Commercial real estate: The good, the bad and the ugly

The commercial real estate market “is a train wreck in slow motion,” said Richard Parkus, head of commercial real estate debt research at Deutsche Bank, Frankfurt, in a Jan. 18 Time magazine article. "Because it's in slow motion, people get this sense that it's really not happening. It is happening.”

Indeed, analysts have been concerned about the health of the commercial real estate market for some time now. At the Outlook 2010 Executive Conference in Washington, D.C., last October, Robert Murray, vice president, economic affairs, McGraw Hill Construction, noted commercial real estate loans were seeing rising delinquencies. “If this gets out of hand, it could be another crisis situation going into 2010,” he told attendees.

During the State of the Industry panel discussion at GlassBuild America: The Glass, Window and Door Expo in Atlanta last fall, Rod Van Buskirk, president, Bacon and Van Buskirk, Champaign, Ill., speculated the commercial real estate market could be “the next shoe to drop” for new construction.

“According to [Daniel Tishman, chairman and CEO of Tishman Construction, New York City], $3.5 trillion worth of projects started in 2007," Van Buskirk said. "So, we have too much capacity, and consequently, not as much need for new construction."

Commercial property prices have fallen 44 percent from their October 2007 peak, according to a Dec. 21 Bloomberg report citing Moody’s Investors Service Inc. As a result, many commercial building owners find themselves upside-down on properties. Their options: sell at a loss, refinance or potentially face foreclosure. By the third quarter of last year, delinquency rates on commercial real estate loans had climbed to 8.74 percent from 1.14 percent in third quarter 2006, according to the Board of Governors of the Federal Reserve System.

Compounding the problem is a high vacancy rate that has left many commercial property owners without rent income. In 2009, the vacancy rate for apartment buildings, for example, reached its highest level since 1965, according to the new report “Commercial Mortgage Defaults in 2010: Hard Times for Some Banks” from SMR Research Corp., Hackettstown, N.J. “Vacancy rates were high as well at shopping centers and office buildings,” the report states.

In an effort to mediate the situation, the FDIC issued a policy statement last fall at www.fdic.gov, urging banks to implement “prudent” commercial real estate loan workouts.

“The financial regulators recognize that financial institutions face significant challenges when working with commercial real estate borrowers that are experiencing diminished operating cash flows, depreciated collateral values, or prolonged sales and rental absorption periods. While CRE borrowers may experience deterioration in their financial condition, many continue to be creditworthy customers who have the willingness and capacity to repay their debts. In such cases, financial institutions and borrowers may find it mutually beneficial to work constructively together,” according to the FDIC statement.

Still, questions remain: If banks choose to ‘work it out’ with commercial property owners, what effect will that have on already tight lending conditions for nonresidential construction projects? When will commercial real estate prices rebound, opening the door for new construction starts?

Conversely, is one man’s loss another man’s gain? Will investors buying commercial real estate for a song have the funds available to upgrade the properties, presenting a possible opportunity for our industry?

To share your take on the current situation, please e-mail me at jchase@glass.org.