Commercial real-estate securities have been Wall Street's last claim to dignity. You might remember that Lehman Brothers Holdings in the final days pinned its hopes for survival on the values of its commercial real-estate portfolio. In planning to spin off $25 billion to $30 billion of real-estate securities into REI Global, Lehman expected to mark the average price of the assets at 85 cents on the dollar–a pretty generous price in a world in which residential real estate securities weren't selling at all and leveraged loans were selling at around 71 cents on the dollar.
Barrack predicts that commercial real estate is due for its turn. It wouldn't be a tremendous surprise; many believed the subprime crisis would soon lead the market wolves to commercial loans.(And read this Heard on the Street column from colleague Lingling Wei).
A commercial real-estate crash would be devastating to the economy. Commercial real-estate loans, including commercial mortgage-backed securities and collateralized debt obligations, total $3.7 trillion. It is only a slow burn right now: Many of those CMBS and CDOs mature in 2010 and 2011, leading Barrack to predict a “refinancing crisis” in the next three years–and with buyers drying up, egress will be difficult. “The overriding problem for all refinancing issues is that sale is not a viable option. Transaction volume is dwindling; to date, retail center sales volumes are down 85%, office is down 75% and hotels 95%,” Barrack wrote.
Who stands to hurt the most? The list starts with the biggest holders of the loans, which include insurance companies, hedge funds and banks, specifically regional banks, Barrack wrote. Even as those banks are struggling with liquidity, they are “the reservoirs of some of the most dangerous pools of commercial real estate loans.” He reasons that investment banks took many of the highest-quality loans, leaving regional banks holding those commercial loans without stable income streams, often from their own banking clients.