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Source link: http://archive.mises.org/10400/the-bottom-hasnt-arrived-for-commercial-real-estate/

The Bottom Hasn’t Arrived for Commercial Real Estate

August 4, 2009 by

“Commercial real estate is also dependent on finance, but it’s far less of a driver for the banks,” Susan Wachter opined in a recent edition of the Opelika-Auburn News. And while Ms. Wachter, a professor of real estate and finance at the University of Pennsylvania’s Wharton School, is right to be bearish on the prospects for commercial real estate, she is far too sanguine about the effects dud commercial real estate loans will have on the nation’s banks.

The Federal Reserve estimates that the commercial property market totals $6.5 trillion, with loans against these properties totaling $3.3 trillion, or roughly a third of the U.S. residential mortgage market. So on the surface, the commercial real estate loan market, appears to be less a threat to bank balance sheets than residential mortgages. However, 60 percent of the nation’s commercial real estate loans are held by small community and regional banks. These banks may only hold 28 percent of the banking industry’s total assets, but they make up over 98 percent of the nation’s 8,200 banks and savings institutions.

Professor Wachter, comfortably tucked away in her Ivory Tower in the shadow of the east coast money center banks, may not be all that concerned about a rash of garden office and strip-shopping center loans hitting the ditch. However, for the vast majority of small banks who didn’t play the sub-prime mortgage game, but are hip deep in commercial construction loans, the plunging of commercial real estate values may spell the end of their existence.

Fifteen years ago less than two percent of U.S. banks and thrifts had exposure to commercial real estate that exceeded five times their Tier I capital, according to a report by Oxford Analytica. But the recent real estate boom seduced most banks into property lending and by late 2008 that ratio had jumped to 12 percent.

With commercial property values down nearly 35 percent from the peak in October 2007 and the downturn just getting started, banks will be feeling the pain for months and years to come. Real estate consultant Foresight Analytics estimates that commercial property losses could reach $250 billion, causing another 700 banks to fail.

The downturn in property values is not due to overbuilding according to professor Wachter, but is entirely due to the financial crisis. That can’t be true with vacancies up and rental rates down, exacerbated by a rash of retailer bankruptcies like Circuit City, Levitz Furniture and Sharper Image. Commercial developers saw the increase in housing as a signal to build more commercial properties to provide services to those new households.

It was the Federal Reserve’s low interest rate policies that provided false signals to the market, leaving homebuilders with homes they couldn’t sell and now commercial properties that aren’t needed. All might be well with the government assisted big Wall Street banks like Goldman Sachs, but the bottom is a long ways off for commercial real estate, threatening the solvency and stability of scores of regional and community banks.


happylee August 4, 2009 at 11:26 am

Mr. French worries too much. Why, just this morning, I discovered that my favorite local bank has $1.4 billion in assets and $878,000 in capital. At the generous capitalization rate of .0006%, my local institution is like a Rock of Gibraltar, ready to weather any pesky storms in the commercial real estate market, where such loans constitute a mere 80% or so of its lending portfolio.

KP August 4, 2009 at 12:17 pm

I would love to see where you got numbers, since 75% of all statistics are made up.

Walt D. August 4, 2009 at 1:43 pm

Can’t be done. If 700 banks need to fail, that’s 14 a week. That’s 10 more than the FDIC can close in a week.

Greg August 4, 2009 at 2:25 pm


First, why would you assume he meant 700 in the next year? In fact, in that very same paragraph, he says the pain will last for months or years to come.

And according to this list:

They have been closing up to 7 per week.

Greg August 4, 2009 at 4:34 pm

How do I short these small banks? Are any of them listed on the bigger exchanges or are they private corps?

Greg August 4, 2009 at 6:55 pm

Other Greg,

I remember seeing a list of banks and their “Texas ratio”. If you’re looking to game, search for publicly traded banks that have a high Texas ratio. It’s a sign that they are in some serious trouble.

Daniel August 4, 2009 at 8:12 pm

LRC has a Texas Ratio list but it’s from the very last days of 2008

Walt D. August 4, 2009 at 11:25 pm

When we see that 7 banks are being closed a week, that does not mean that they all of a sudden became bankrupt last week. Think of it in terms of a funeral parlor that can only handle 7 people a day. The 700 people all died from the same cause months ago.
In all likelihood, many of the too-big-to-fail banks are also bankrupt and are being kept afloat “until the economy recovers and house price go back to normal (bubble level) levels”.

Kes August 5, 2009 at 2:10 am

The pain will be over for consumers and the “average” person much sooner than it will for the commercial world, especially banks as mentioned above.

Ron August 5, 2009 at 6:09 am

“I would love to see where you got numbers, since 75% of all statistics are made up.”

KT, is it fair to assume there’s a 75% chance that you made up this statistic?

KP August 5, 2009 at 7:53 am


Sarcasm is over your head I see. Without any citations, I take this article as it is; nothing.

J Cortez August 5, 2009 at 8:51 am

KP, he cited the Opelika-Auburn News, a report by Oxford Analytica and the Federal Reserve’s own statistics.

Also, Mr. French used to work in the banking industry before working at the institute. I think it is safe to say he has some knowledge on the subject.

Walt D. August 5, 2009 at 3:23 pm

“I would love to see where you got numbers, since 75% of all statistics are made up.”
I’d like to see 25% that are <>not made up.
Incidentally, Moody’s and S&P’s were criticized for being over-generous with their AAA ratings on senior tranches of mortgage backed securities. It seems that they have not learned their lesson. Given what happened to Chrysler secured bonds during the recent bankruptcy reorganization, they should adjust down all corporate AAA ratings, if they follow their own guidelines, since the rules of priority of claim are subject to arbitrary change (at the whim of the Federal Government).

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dominican republic real estate September 20, 2010 at 2:07 am

I am amazed with the statistics you provided in your post. Have you done the research or you just made a rough estimation on it…. otherwise the post is awesome and very relevant for the commercial real estate purpose.

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NeilWechsler February 9, 2011 at 11:50 pm

I used to work in real estate Austin TX area until 2007. After this year real estate sales dropped down drastically, though many construction firms were still building commercial properties. These days I have been talking with a friend of mine that works in the field and told me that because of the banks that lowered the conditions for mortgages, the sales have slightly increased and it will slowly increase in the years to come.

Elizabeth May 3, 2011 at 9:42 pm

I think it is smart to get a great Missouri reverse mortgage these days. I have found that with the payment plan or a lump sum I can get the work done around the house that needs to get done. It is a great idea for a way to get the money you need.

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