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Commercial real estate market staggers through financial crisis

Alex Veiga
AP Real Estate Writer

The residential housing market went into a tailspin over a burst housing bubble and a whole lot of bad mortgages. The commercial real estate market has suffered a different sort of one-two punch.

Between the recession and the financial crisis, many commercial property owners were left struggling, and many banks were stuck with troubled loans on everything from shopping malls and hotels to office buildings. Exposure to commercial real estate fueled losses at major banks such as Morgan Stanley, which reported a second-quarter loss of more than $1.2 billion Wednesday.

Market observers say prospects are not good for a turnaround in the near future because the commercial real estate market’s fortunes depend largely on free-flowing credit markets and cranked up spending by businesses and consumers — neither of which economists expect will happen soon.

That means more commercial property loan defaults are likely, and that could mean trouble for the still-recovering U.S. banking system.

Here are some questions and answers on the problems facing the commercial real estate market and what they might mean for the rest of the U.S. economy.

Q: How has the financial meltdown affected the commercial real estate market?

A: The recession and rising unemployment have stifled demand for rental space, resulting in higher vacancy rates. Lenders have tightened underwriting standards, making it much harder for property owners to refinance and for would-be buyers to qualify for financing.

Those factors are contributing to a dearth of sales, a spike in commercial loan defaults and falling property values.

Q: What’s happened to the value of commercial real estate during the economic downturn?

A: So far, commercial property values have declined as much as 45 percent off their peak in 2007, Richard Parkus, an analyst with Deutsche Bank Securities, recently told a congressional committee examining the danger posed by rising commercial property defaults.

Q: Where are vacancy rates projected to go?

A: Marcus & Millichap Real Estate Investment Services projects U.S. vacancy rates this year will hit 17.6 percent for office space, 11 percent for retail, 12.6 percent for industrial and 8.2 percent for apartments.

Two years ago, the vacancy rate was 12.6 percent for office space, 7.2 percent for retail, 9.4 percent for industrial and 5.7 percent for apartments.

Q: What happens when commercial property owners aren’t making money and can’t refinance their loans?

A: Often, if they can’t find a buyer to take the property off their hands or renegotiate an extension with the lender, they end up losing the property to foreclosure. Some, however, have filed for bankruptcy protection.

Q: What effect could rising commercial property defaults have on the U.S. banking system?

A: It could deliver a serious hit to the bottom line at banks that make commercial real estate loans.
Delinquency rates on such loans have doubled in the past year to 7 percent, according to the Federal Reserve. Small and regional banks face the greatest risk of severe losses from the loans.

Parkus estimated total losses in investments backed by commercial property loans could be as high as $90 billion in coming years. He projected losses on commercial real estate loans held directly by banks could reach $150 billion.

Q: What’s the government doing to help?

A: Last month, the federal government opened part of the consumer lending program known as the Term-Asset-Backed Securities Loan Facility to commercial real estate loans. The expectation is that will boost the availability of loans, helping to prevent defaults and generate sales.

Industry groups are now pushing to extend this program through the end of next year.

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