I think it was some famous economist — either John Maynard Keynes or Ice-T — who once said, “I’ll never go broke, I got property.”
That may be true, but only if you haven’t leveraged your real estate and can afford the increasing taxes which are likely as state and local governments look to tap any revenue source they can find.
With record foreclosures, plummeting prices and an overhang of supply in the housing market, another real estate crisis also appears to be imminent.
Builders are warning a new financial catastrophe may be looming in the commercial real estate market.
If the story sounds familiar, it’s basically a rehash of the lending excesses which caused problems in the housing market.
Banks, in particular smaller local banks, boosted lending to commercial real estate owners and developers over the past 20 years. The conventional wisdom was business real estate would be a more reliable source of income than individual homeowners.
As is often the case, it turns out the conventional wisdom just meant there were a lot of people making the same faulty assumptions.
With the recession, the owners of shopping malls, hotels, office space and apartment buildings are all seeing falling occupancy rates.
A slowing economy also puts pressure on commercial property owners in other ways:
Massive layoffs have left office buildings with unrented space. The slowdown in consumer spending is hitting owners of malls and retail space where foot traffic has dried up. Hotel owners have been hurt by the slowdown in travel and tourism.
Miami’s ritzy hotel The Shore Club offers one case in point. The hotel was appraised and mortgaged for $176 million as the Florida real estate market got particularly frothy in 2005.
The hotel’s occupancy rate was 54% in the second quarter of 2009, down from 66.5% a year earlier. Revenue per available room was also down 40% to $151.44 from $251.17 during the same period. The hotel recently was declared delinquent on its $111.5 million mortgage.
The good news is the commercial real estate market is much smaller than the residential market. The residential housing market represents a $22 trillion sector of the economy. By contrast, the commercial real estate market is estimated to be around $6.4 trillion.
The bad news: problems in the commercial market could spill over into the residential market as losses on commercial properties could cause banks to curtail overall credit extension and, in many cases, accelerate sales of foreclosed houses in order to help offset more illiquid commercial real estate properties.
There are other problems in the commercial market as well. Commercial loans tend to be much shorter than home mortgages. Many commercial mortgages have terms of only three to seven years and are the mainstay of most smaller bank portfolios.
As MSNBC reports:
For smaller banks with assets under $1 billion the concentration [of commercial real estate loans] is even higher. Some 74 percent of all loans held by smaller banks are secured by commercial real estate. These roughly 6,500 banks represent some 90 percent of all U.S. banks.
As it turns out, Ice-T’s residuals from Law and Order may represent a better deal than any property he holds.
Just like a real hotel … it’s empty inside.
Image: Zuma Press