The murmurs are growing louder, and are being heard from Congress, economy watchers, and even the media. Commercial real estate conditions are deteriorating, and that has real potential to inflict further damage on an already weakened economy. Experts have expressed concern about the potentials for thousands more bank failures, due to commercial real estate debt exposure. Many predict a melt-down similar to the one experienced in the home mortgage realm, which would exasperate already tight credit conditions, further restricting the availability of consumer credit and further hampering consumer spending. And, in an economy so heavily reliant on consumer spending, that could have broad ramifications.
“The growing bubble in the commercial real estate industry has the potential to infect our economy and slow a recovery," said Chairman Kanjorski, in a formal, bipartisan letter written to Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke. "In order to safeguard the businesses operating on Main Street and protect the millions of jobs depending on commercial real estate, the Treasury and the Federal Reserve now must take needed and urgent action to stave off a potentially devastating wave of commercial real estate foreclosures and bank losses." Chairman Kanjorski, who is a Democrat and Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, was joined in the letter by 78 other Republican and Democratic Congressmen.
“There's been an enormous bubble in commercial real estate, and it has to come down," said Elizabeth Warren, chairman of the Congressional Oversight Panel, as quoted by the Washington Post in a February 19, 2010, article. The Congressional Oversight Panel was congressionally created to monitor the financial bailout process. “There will be significant bankruptcies among developers and significant failures among community banks." According to the article, “nearly 3,000 community banks -- 40 percent of the banking system -- have a high proportion of commercial real estate loans relative to their capital, said Warren.” Warren estimates that “half of commercial real estate mortgages will be underwater” as 2011 begins.
According to Chairman Kanjorski’s letter to Geithner and Bernanke, printed in full on his website and citing data from real estate data provider Trepp, “the delinquency rate for loans underlying commercial mortgage-backed securities (CMBS) ballooned 500 percent in 2009.” On February 11, 2010, Housing Wire reported “commercial property values dropped 40% since the start of 2007. Falling values push higher loan-to-value ratios, which constrict abilities to refinance.” In addition to the losses that lenders are dealing with in residential real estate as foreclosure rates continue to be record breaking, as noted in a March 5, 2010, article by Alain Sherter citing information from the FDIC, commercial real estate charge-offs “shot up 131 percent in the fourth quarter of 2009.”
Sherter also explained that “just as giant financial firms interconnect, so do giant financial crises. Credit woes seep first into the banking sector, then slam into the broader economy before doubling back to curtail lending. Bubble pops bubble, a veritable multiverse of economic pain.” And, that is where we find ourselves today.
The national economy, as well as that of the entire world, shuddered under the bursting of housing bubble. Banks, lenders, and investors experienced massive losses, which moved through the economy, affecting a broad range of economic activity, including consumer spending, which fell dramatically. The housing bubble aftermath is also seen in record levels of foreclosure and unemployment, as well as in what a February 24, 2010, Wall Street Journal article referred to banks’ “sharpest decline in lending since 1942.”
And now we face the bursting of another bubble – commercial real estate. The loss potentials are enormous. According to the Congressional Oversight Panel report, between now and 2014, $1.4 trillion worth of commercial real estate loans will be coming due, while property values fall below levels that make refinancing a viable option, commercial property vacancies rise, and commercial property rents are pressured downwards. Commercial foreclosures can be expected to increase, along with further losses to lenders, and an economic aftermath similar to that experienced after the housing crash. After all, as commercial real estate properties are foreclosed upon and businesses close, there will be more people losing jobs, and less money for consumer spending.
Less money for consumer spending can lead to further decreases in profit for businesses, which can result in increased lay-offs and then, as profits take further hits, more foreclosures. Naturally, as banks and lenders experience further losses, a corresponding tighter credit contraction can be expected, reducing credit available to small businesses and consumers. Reduced consumer credit can further depress consumer spending.
All of these factors contribute to further economic difficulties, such as a reduction in the amount of tax dollars collected by local, state, and federal government, as noted in a recent report by Center on Budget and Policy Priorities. According to the report, titled “State Tax Changes in Response to the Recession”, because of the economic difficulties being experienced throughout the nation, “states took in $87 billion less in tax revenue from October 2008 through September 2009 than they collected in the previous 12 months.” This drop is “the steepest on record.” It is an ugly cycle, one that is difficult to break out of.
Buying into the concept of recovery right now is a dangerous financial move. The commercial real estate problem is right there on the fiscal horizon, and it cannot help but affect the entire economy, similar to the way the housing crash did. Financial decisions, then, should be made with care, with the understanding that further economic difficulties are, in all likelihood, to be expected. Smart financial planning, with a focus on decreasing, if not altogether eliminating, debt and increasing personal savings, with an eye on being able to survive a period of unemployment or some other financial crisis, should be the order of the day.