Monday, November 9, 2009

CRE creeping.

I've been trying to understand the mechanisms of Commercial Real Estate for a couple of years now, because I've been concerned that Bend is completely overbuilt. The Nov. 6th entry of Financial Armageddon is a primer for the mechanics of CRE, gathering together 6 different articles on CRE. It's worth a read....

Here are my thoughts after reading them:

If it's true that downtown Bend real estate increased in value from 1997 to 2007 by 1600%, it's almost inevitable that developers over-invested in old buildings, new buildings, and renovated buildings. Especially the latter two.

Picture one of the new downtown buildings, which as little as a couple of years ago were asking 2.00 to 3.00 a foot for retail rent. Assuming that they got their loan with those figures in mind, how much of that loan was predicated on full occupancy?

The problem is this. They might be able to get 2.50 a foot for 50% occupancy, or 1.50 a foot for 90% occupancy, but in today's market what are the odds they can 2.50 a foot for 90% occupancy?

I recently checked on a prime piece of downtown retail that was asking 1.25 a foot.

Business Weeks quotes:

"...billionaire investor Wilbur Ross: "Commercial real estate has gone from being highly liquid at sky-high prices to being extremely illiquid at distressed prices."

Anyway, I kept hearing the term "coming due" on CRE, and didn't understand how that worked. Obviously, it isn't like a fixed residential loan. I was guessing that there was some form of low payments while the building was being built and rented, and then a balloon payment as the rents started rolling in. (Or the condo sales...)

Looks like that was a pretty good assumption. From the Atlantic Business Channel, quoted in the Financial Armageddon site:

"It should be a really, really worrying statistic that 9% of all CRE loans are delinquent -- because it isn't that hard for most of these loans to make monthly payments. Commercial mortgages are generally structured differently from fixed-rate residential mortgages. Many require relatively low monthly payments for the term of the loan, with a larger balloon payment due upon the loans' maturity. So if a large portion of commercial borrowers can't even make those relatively easier monthly payments, then we'll see some far more serious problems once those balloons come due."

You have to figure that many of these commercial loans are going to come due in the next couple of years in Bend. That's why we should be worried about local banking institutions, as well, because they are most heavily invested commercial real estate:

"...this year, smaller lenders and community banks are going bust at an alarming rate because of their exposure to souring commercial real estate loans." New Jersey Business News, 11/9/09

If local banks and resorts are ALREADY having trouble, it's probably only going to get worse.

Yes, downtown Bend is filling up. But with lower rents. Which will probably make it that much harder for the New buildings to pay off.

From the San Francisco Chronicle:

"No quick recovery is in store," the report said. "2010 looks like an unavoidable bloodbath for a multitude of 'zombie' borrowers, investors and lenders," it said. "The shake-out period may extend several years as even some conservative owners with well-underwritten loans from the early 2000s see their equity destroyed."

The local banks CRE exposure is so bad, the Fed's have relaxed some of the rules, allowing for a Pretend and Extend strategy. But from what I'm reading, this will only delay the inevitable.

My earlier researches into CRE mostly talked about how most of the bigger lending institutions were effectively frozen a couple of years ago, putting an end to most new commercial developments.

Only now are the consequences of the earlier over-building becoming as equally clear to me.


RDC said...

Figure that a lot of CRE loans are 5 year interest only with the rest do in a balloon payment at the end. That would make the ones that were taken out at the peak becoming due in the 2011-2012 time frame. That is if the holders actually keep paying on them with the properties themselves being way under water.

Duncan McGeary said...

It was nice meeting you, RDC!

RDC said...

I thoroughly enjoyed my visit to your lair.

Your store certainly fits into a category all of its own.

Duncan McGeary said...


Sort of like, "How'd you like my book?"

"It was.....interesting."

RDC said...

It was a compliment. Really it was.

It demonstrates how success often does not fit into easily defined visions.