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That Other Foreclosure Crisis: Commercial Real Estate Teeters

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Back in February, 2010, before she was the Left's great hope in Massachusetts, Elizabeth Warren authored a report that began with a dire prediction:  "A significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American."

If the wave crashed since, it did so quietly. Commercial real estate hasn't been at the center of recent economic news or disputes. Any hard fall has likely been softened by the hot rise in renting, which continues to be a boon for the market. But, as Joe Tyrrell reports, the threat of commercial decline is still very much alive in New Jersey:

For many businesses beyond Wall Street and Detroit, economic consequences have hit outside the spotlight. In New Jersey, the continued rise in foreclosures has been most pronounced on commercial properties.State court records show only one commercial business in New Jersey was hit with a foreclosure action in October 2006. A year later, there were 60. For October 2011, the number was 165.

For all of 2006, there were 173 commercial foreclosures in the state. Last year’s total was 1,586.

In some respects, the explanation is simple. When things got bad, the real estate market turned quickly, before companies could respond.

Tyrrell goes on to document the litany of reasons why---the tight lending markets, the messy refinancing structures, the fear that if interest rates rise problems will worsen. He doesn't mention the Federal loan restrictions that hold back mixed-use lending in dense areas. That may not be a major hindrance in the state, but I suspect it's there. Although, an analyst tells him that the chief victims are "mom and pop" retail stores in business districts.

Some of the troubles are unique to New Jersey cities. Yet there are signs that, across the country, more foreclosures may come. A recent report from Trepp, LLC, pegs the CMBS delinquency rate as rising 31 basis points last month, leaving an outstanding debt pile of $58.1 billion. Most commercial loans are shorter than residential loans, with briefer amortization horizons and a big balloon payment that pops at the end. So delinquency is not a good sign. And last month was not inconsistent with the trend over the past few years, as this Harvard Business Law Review charts:

Next to residential rates, this is nothing. (The Warren report estimated commercial debt at less than a third of the $10.6 trillion in residential real estate debt.) But the trend is troubling, as the bond markets are pointing out. A further spike in delinquencies would strain banks and then dry up funds for future commercial borrowers.

A coming spread of commercial foreclosures, however, might be isolated to struggling, sprawling places, like New Jersey cities. Consider this story from earlier today, out of San Francisco (via Calculated Risk), on the city's first "spec" development, sans signed tenants, since 2007. The development is slated to be financed entirely through equity, with not a drop of debt.

As the Harvard report author, Tanya Marsh, argues, there's plenty of room to dissect why commercial properties in New Jersey are going under, and what could be done about it. (She disagrees with Warren's narrative of the lax regulatory culprit.) It's worth noting that a significant source of the rise in CMBS loan problems comes from retail buildings. And as Matt Yglesias wrote, when parsing the latest jobs numbers, commercial retail is simply dying.

Loan restructuring and credit easing and interest rate guarantees won't go all that far if people just aren't buying your stuff.

Photo:  cc/chrisjohnbeckett