If You Think the Housing Meltdown Was Bad…………

I recently read an article by Doug Hornig entitled “If You Thought the Housing Meltdown Was Bad……wait until you see what’s in the cards for commercial real estate”.  Now I’ve written about the pending commercial foreclosure crisis before but I’ll have to admit, I’ve been so caught up in the residential crisis and all of its permutations that I kind of let the commercial issue slip to the back of my mind.  So, Doug’s article definitely “snapped me to attention” again.  The breadth and depth of our current economic “upheaval” is more then just a bit too complicated for most of us to understand.  But, I think we can all agree that the mortgage lending industry is at the heart of the problem.  The failures in that market segment have extended their tentacles out and have touched every other segment of our economy – impacting building, manufacturing, professional services, consumerism, and ………….

According to Hornig, the next big problem is commercial real estate.  Here are the opening couple of lines in his article: “That’s right, the next train wreck will be in commercial real estate. Couldn’t be worse than last year’s residential market crash? That remains to be seen. But it’s coming soon, probably as early as the second quarter of next year, and there’s nothing that can prevent it.” Hornig derives a lot of his information from one of the most knowledgeable commercial real estate professionals in the industry, Andy Miller.

Miller, of the Miller Fishman Group of Denver, reports that two years ago commercial real estate carried a value of about $6.5 Trillion and that real estate was supported by about $3.3 Trillion in loans.  Well today the loan amount hasn’t changed much but the value has been estimated to be about half of what it was two years ago!  Oops!  The commercial market is “under water”.  That means writing down about half to two-thirds of these loans.  Now if the banks were to have to take that hit all at once, then, according to Miller, “there won’t be any banks”.

Adding to the problem is the fact that, like residential loans, these commercial loans were also bundled into exotic financial vehicles, called commercial mortgage-backed securities, which were sold and resold on Wall Street for great profits.  And who do you think purchased most of these exotic securities?  You guessed it – the banks!

So, here is the situation as it is described by Miller:”What happens to a property when its value drops way below the loan, a seller can’t get enough money to get out, a buyer can’t raise enough money to get in, and the bank can’t afford to foreclose? Simple. It just sits there, carried along on the bank’s books at some inflated “mark to fantasy” price that makes the institution’s balance sheet look passable.”

The bottom line is our financial economy is in for another major hit that –in turn – will effect all of us.  As this commercial crisis escalates the banks will do the same thing they did last year: “run to the government palms outstretched”.  Who knows how long it will take us to recover from this new set of pressures.  One thing is for sure, you can expect real estate prices to continue to drop for the near future.  Check out this article and see what you think.

Paul Davis, Market Advisors