A lot has been made about the plight of commercial real estate. With prices off over 30% from peak levels, there's not much to be optimistic about: commercial property sales are plummeting, and vacancies are rising along with unemployment. This does not bode well for future bank earnings. From the WSJ, Unfinished Real Estate Projects Weigh on Banks:
For its neighbors in the city's wealthiest area, the Streets of Buckhead is an unfinished eyesore, not the glitzy shopping district promised at the height of the real-estate boom.Extend and pretend at its finest. Although certain types of commercial real estate have been firming up, properties under construction are very vulnerable to sustained weakness in the economy. There will come a point when banks will have to face reality and take losses, but of course, not before taking one last dip into the bonus cookie jar.
For Bank of America Corp., the project's biggest lender, it is a microcosm of commercial-real-estate problems faced by banks nationwide as builders default on loans and valuations tumble.
The project's developer is in talks to raise $200 million to complete the stalled project. As part of the deal, Bank of America is negotiating to potentially swallow a loss on the $160 million loan it made to the developer before construction began, people familiar with the matter said.
The bank is not alone. Lenders across the country are being forced to make unpalatable choices, including putting up more cash, extending loans or agreeing to lower their rights to collect on the debts, as they try to keep projects afloat.
Non-Performing Loans Rising
Today, Streets of Buckhead is one of many high-profile developments in the country halted by the economic downturn and financing drought. Real-estate developments are among the biggest headaches for banks because they are huge capital drains and, in most instances, demand for space and rents in their markets are falling below projections. As of the fourth quarter, about 20% of $440 billion of construction loans outstanding were more than 30 days past due, according to Foresight Analytics, compared to 11.4 % a year ago.Delinquencies are still rising for commercial real estate properties. Note that tremendous weakness in commercial real estate is occurring against a backdrop of massive governmental support (TARP). This does not augur a quick recovery in commercial real estate valuations.
Praying for a Recovery
Banks will have their hands full in the coming months. About $566 billion in commercial real-estate debt, the majority of which was provided by banks, comes due in 2010 and 2011, according to Oakland, Calif., research firm Foresight Analytics LLC. The struggling commercial real-estate loan market is increasingly cited by bank regulators as a growing concern. The Federal Reserve's Jan. 13 "beige book" survey of regional economies said commercial property markets remained weak.If the commercial real estate market remains at depressed levels, there will be a cascade of defaults, since loans are collateralized by the value of the property. Rising defaults will further pressure commercial real estate valuations.
The report highlighted loan restructurings, noting, "There is still some concern over how commercial-real-estate loans will be worked out as they come due, given the decline in collateral value."
Either commercial real estate prices start rising soon, which is heavily dependent on the employment picture, or we are primed for the next leg down in commercial real estate. It will be interesting to see how long banks can hold out before capitulating.
This post has been republished from Moses Kim's blog, Expected Returns.