Commercial Real Estate Faces "Reckoning"

Quoting Green Street Advisors, Bloomberg says commercial real estate is facing a "reckoning."

This is one reason why it's so hard to get a read on the true state of the sector. On one hand, we hear a lot of arguments that commercial real estate didn't experience the same kind of bubble as residential real estate. Values are down and fundamentals are weakening, but we're not seeing the historic kind of crash that is happening on the residential side.

On the flip side, there seems to be a lot of fear that things got too frothy in 2005, 2006 and 2007. Values got too high, lending got too generous and underwriting got too loose. There's a feeling that we're just in a waiting period until the damage from those days gets unleashed.

"The day of reckoning for commercial real estate has been delayed, not dodged, and the delay means that markets for commercial real estate will remain discombobulated long after conditions have improved elsewhere,'' wrote Mike Kirby, chairman and director of research of Green Street, the Newport Beach, California-based firm that analyzes real estate investment trusts.

Values for commercial properties have dropped 20 percent from their 2007 peak, yet delinquency rates have been low in part because many loans taken out from 2005 to 2007 were interest-only, requiring no immediate paydown of principal, Kirby said in the firm's October outlook report.

Low delinquency rates make the commercial market "feel healthier'' than the housing market, Kirby wrote. Delinquencies are "certain to shoot higher,'' as the economy weakens and borrowing costs rise, he said.

A record $600 billion of commercial mortgage-backed securities were originated between 2005 and 2007. The annual pace in those three years was almost triple the $70 billion a year originated in the first five years of this decade. Those loans now account for almost two-thirds of outstanding CMBS, Kirby said.

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