In a committee hearing in Congress that just ended, Joint Economic Committee Chairwoman Carolyn Maloney said that commercial real estate is a "ticking time bomb." That comment alone has generated a Dow Jones story, an Associated Press story, a blog entry at the Washington Post, a Reuters story, a CNBC story and a Bloomberg story.
The comment came in early in the hearing, which includes testimony from Jon Greenlee, Associate Director, Division of Banking Supervision and Regulation, Federal Reserve Board of Governors; Richard Parkus, Head of CMBS and ABS Synthetics Research, Deutsche Bank Securities; Jeffrey D. DeBoer, President & Chief Executive Officer, The Real Estate Roundtable and James Helsel, Partner, RSR Realtors, Harrisburg, PA and Treasurer, National Association of Realtors. All of their witness statements can be read at the bottom of this page.
One question: How can commercial real estate be a "ticking time bomb" when we're already more than two years into the sector's decline? This testimony is occurring as a wave of new data hits us that shows that commercial real estate has already been hit very, very hard. We got the June same-store sales data today. Sales came in down between 4.3 percent and 5.1 percent, depending on whose numbers you look at. Reis also released new numbers on shopping center and regional mall vacancies showing vacancies have hit 17-year highs. A report from Real Capital Analytics shows that commercial real estate worth $108 billion is now in default, foreclosure or bankruptcy. Isn't the correction playing out? What exactly does the industry need?
The real problem at hand is the volume of refinancing that needs to be done in the coming years in the face of the fact that the securitization machine--which had accounted for up to 40 percent of annual commercial real estate financing by 2006 and 2007--is completely shut down. Other sources of financing--commercial banks, life insurance companies, etc.--are still out there. They have tightened underwriting standards for sure and loan sizes are dramatically smaller than in the past. But they are out there. Moreover, there are government programs in place to address this--namely, the TALF and the PPIP. In fact, today there were more announcements about PPIP that should supposedly get the program moving. (To be fair, though, there are major doubts that the PPIP will ever work.)
There is certainly a mess out there. And the delinquencies, defaults and foreclosures will continue to mount. But while lobbyists are taking the situation as an opportunity to convince the government to lend a helping hand, doesn't the current dilemma--the volume of refinancing being much larger than the appetite of lenders to offer debt--get at a key problem in how commercial real estate financing is structured? Maybe it's not such a great idea to have short-term loans on commercial real estate set up with huge balloon payments at the end of the loan terms. It sets up scenarios where the incentive is not to pay down the loan, but instead to sell the property or to refinance and keep rolling the debt over. Does leaving commercial real estate permanently encumbered by debt make sense? There are plenty of owners that prefer to own assets free and clear with little or no debt against them. The current credit situation makes an argument that a more conservative debt structure is a better and safer business model. Perhaps we shouldn't turn around and prop up a system that has proved to be so unstable. I also wonder how the players that have been more conservative and haven't leveraged to the hilt feel about investors who took out too much debt getting bailed out by the government? What does all of this say about the concept of "moral hazard?" If the government steps in and restarts securitization, that just creates incentives to keep the same financing model in place rather than having the industry amend its business practices.
It will be interesting to read the full testimony of the hearing. I only caught snippets of what the panel had to say. It seems like at the very least the industry lobbyists are looking for further extensions to TALF. But how much more legislation or government-backed programs does the commercial real estate industry need to weather the current storm? That's ultimately the question I'd like to hear an answer to.