A Slow-Motion Wreck for Commercial Real Estate

The commercial real estate crisis, the next big financial debacle, is quietly unfolding with little fanfare, but it will last for years, not weeks. Fox recently toured the warehouses and industrial parks of eastern Los Angeles County; with the phenomenal growth of foreign trade passing through the ports of this area in recent decades, it had become a distribution boomtown.

Now, it is one sad tale after another. Take the small industrial park built recently by a local businessman. It's got tenants, and the owner has been making the mortgage payments. But when his loan comes due he almost certainly won't be able to refinance because building prices have dropped and lending standards have tightened; he will either have to come up with cash or lose the property.

That's just one of many common predicaments. Commercial mortgages are about to hit a refinancing wall; more than 65% of the loans that have been packaged into commercial mortgage-backed securities won't qualify for refinancing when they come due, and banks are already facing painful choices about what to do with short-term land and construction loans that will never be paid off in full.

The commercial meltdown will take a long time to unwind for two reasons: while commercial real estate lenders got sloppy during the boom, they didn't go crazy the way their residential peers did; and while most residential mortgages are chopped into securities and sold, the bulk of commercial mortgages and virtually all land and construction loans stay on banks' books. Banks can delay recognizing losses on these loans. With total commercial real estate losses of $200-$300 billion or more, regulators have so far encouraged banks to exploit that leeway.

This gives banks time to work out problem loans in an orderly fashion, and averts a big hit to the FDIC's empty insurance fund. The downside is that it drags out the correction for years, delaying any rebound. The smart money is waiting for the bottom to materialize; it may still be waiting a year from now.

Read A Slow-Motion Wreck for Commercial Real Estate by Justin Fox