Commercial Real Estate Woes Will Cost Banks $300bn: COP
Financial institutions could face $300bn in losses related to commercial real estate in 2011 and beyond, putting smaller banks at the most risk, according to a report from the Congressional Oversight Panel (COP). Congress established COP in October 2008 to oversee the spending of the $700bn from the Troubled Asset Relief Program (TARP). Between 2010 and 2014, the Panel found that $1.4trn in commercial real estate will mature, and almost half are currently underwater. The real estate research firm, Foresight Analytics, found the same statistic in a recent study. According to Foresight, $770bn in commercial loans will be in negative equity between 2010 and 2014. When the loans reach the end of the term – usually three to 10 years – the borrower takes out a new loan to stay in the property. But unemployment still hovering around 10%, offices, hotels and retail shops are emptying out. The owners of these properties either can’t pay interest and principal during the loan’s term or cannot get a refinancing with the term ends, according to the report. Commercial property values dropped 40% since the start of 2007. Falling values push higher loan-to-value ratios, which constrict abilities to refinance. The downward pressure comes from heightened vacancy rates and decreasing rents. Vacancies range from 8% for multifamily housing to 18% for office buildings. Rents dropped 40% for office space and 33% for retail space, according to the report. “Without more people in stores, more people at hotels, more people able to afford new or larger apartments, and more businesses seeking new or larger office space and other commercial property, the markets cannot recover and the credit and term risk created by commercial real estate loans cannot abate without the potential imposition of substantial costs on lenders,” according to the report. The commercial real estate problem “will fall disproportionately” on smaller regional and community banks with higher exposure to the loans compared to the larger institutions. COP had a harder time predicting the potential victims on the securitization side, but, according to the report, investors hold less risk. Banks have more exposure than commercial mortgage-backed securities (CMBS) because, unlike residential real estate, the properties serving as collateral are of a higher quality. In residential mortgage-backed securities (RMBS), banks generally kept the best mortgages and securitized the riskier ones, according to the report. But according to the real estate data provider Trepp, CMBS investors aren’t free and clear. The rate of 30-plus-day delinquency in CMBS reached 6.49% in January, a record high. “There is a commercial real estate crisis on the horizon, and there are no easy solutions to the risks commercial real estate may pose to the financial system and the public,” according to the report. “The Panel is concerned that until Treasury and bank supervisors take coordinated action to address forthrightly and transparently the state of the commercial real estate markets – and the potential impact that a breakdown in those markets could have on local communities, small businesses, and individuals – the financial crisis will not end.” Write to Jon Prior.