Will Recovering Capital Markets Catch the Other Commercial Real Estate Shoe Before It Drops?

In previous blogs, I’ve written about the potential perils of lending, credit, and capital markets, and have asked the question:  As the Economy Stabilizes, Will Commercial Real Estate Markets Worsen?  I also discussed how investors and corporate occupants have recently been successful in buying office buildings for One Year’s Rent!

With $1.4 trillion in commercial debt expiring and in need of replacement over the next three to four years, many of us in the commercial real estate industry are asking ourselves:  “If the next shoe drops in commercial real estate, will the bottom fall out of the economic recovery?”

Let’s consider some of what’s going on:

  • Securities markets remain volatile
  • Credit markets appear to be moving slightly, but are doing so cautiously
  • Europe?  Don’t get me started!
  • The BP oil spill debacle in the Gulf of Mexico?  Too many bad things to say here about too many people!
  • Banks are still not aggressively lending for commercial real estate (Loans-to-value, recourse, and other important metrics are loosening, but are still rather challenging)
  • Despite a large portion of the nation’s commercial  real estate being owned by institutional investors, the majority of commercial properties are owned by private entities

One of the challenges in jump starting commercial real estate markets, that differs from the last declining real estate cycle, is that a majority of previously placed commercial real estate debt was securitized.  Replacing such debt now, often requires arduous negotiations and decision-making on broad and deep levels.  Challenges associated with time and cost of restructuring securitized debt has proven overwhelming to some borrowers, forcing foreclosure and deeds-in-lieu of foreclosure actions.

Some banks, becoming saturated with delinquent loans, non-performing properties, pending foreclosures, forbearance, and foreclosure avoidance procedures, simply will not or cannot return to lending in the near term.  They have become, in essence, property disposition servicers.  We’ve seen that before…can anyone say “Resolution Trust Corporation”?

In the current environment, banks and other lenders are more likely to lend on fully leased commercial properties.   Such properties represent the minority of those seeking funding.  Other lenders are focused primarily on residential properties, and are offering loan terms that are considerably more favorable than those available for commercial properties.  As a result, many commercial investors have moved into residential real estate investing.

How will the economy work its way through these challenges?  What must occur in order for commercial real estate markets to truly stabilize?  Can banks simply lend their way out of this?  Will recovering capital markets catch that other shoe?  What are your thoughts?

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