Monday, August 17, 2009

Commercial Real Estate

There continues to be much concern over the commercial real estate market. This is mentioned frequently in the consumer press, and we have had clients ask about what risks we see for the entire economy.

Commercial real estate is suffering from high levels of debt incurred in the days of low interest rates of 2007 and prior, and the high prices paid for some real estate that the debt was used to acquire. The financing came from banks and also from Commercial Mortgage Backed Securities (CMBS). This debt does not have the long maturities of residential housing, with significant amounts of 3 to 7-year paper scheduled to mature over the next few years. It is this maturing debt, and the now lower prices of real estate, that has some observers so concerned.

Goldman Sachs was recently quoted in the press as expecting another 20% price decline in commercial real estate. Companies are downsizing (thus reducing their demand for real estate) and debt holders may be liquidating real estate collateral, so additional price declines make sense to us. Certain commercial REITS and others who have high levels of debt are at significant risk in this environment.

We did note just today the announcement that the government TALF program (where the Fed makes low cost loans to acquirers of asset-backed securities including CMBS) that was scheduled to end December 31, 2009 has been extended for an additional 6 months as to CMBS. The Fed is trying to improve liquidity for commercial real estate with this extension and it is reasonable to think the government will provide additional assistance in commercial real estate if they feel it necessary.

Our conclusion: commercial real estate price deflation and defaults in the debt secured by such real estate is a legitimate concern as to the economy. We would think the government would do what they could to soften the economic blows from this problem, but it is one more headwind the economy and markets will have to deal with.