Real estate woes seep into malls, office towers
The Treasury readies $1 trillion to buoy faltering properties.
New York
Now it鈥檚 the real estate developers who are slated to get a bailout.
By April, the federal government expects to have a plan to refinance office towers and shopping centers in danger of defaulting. The scale is likely to be massive: Last week Federal Reserve Chairman Ben Bernanke hinted at providing another $1 trillion in credit.
The goal, he said, is to head off a 鈥渓ooming crisis鈥� that could spread far beyond 鈥淔or Rent鈥� signs and shuttered mall shops. For now, commercial delinquencies are few. But office vacancy rates are heading toward record levels, according to one estimate, and banks are exposed, with $1.72 trillion in commercial real estate loans outstanding as of Feb. 18.
Just as significant, many insurance companies and pension funds have invested in real estate, putting them at risk, as well.
鈥淭he need is urgent,鈥� says Kenneth Rosen, a professor of real estate at the University of California in Berkeley. 鈥淚t is important to get this done before we have another problem.鈥�
Due: $300 billion
This year some $300 billion in loans to developers are due to be refinanced by commercial banks. Given the decline in the economy, many real estate ventures might not be able to survive if they are not able to refinance their loans on better terms more reflective of today鈥檚 economic conditions. But banks are largely refusing to refinance as the properties drop in value.
Any bailout of real estate developers 鈥� some of whom are known for their extravagant living (think Donald Trump) 鈥� would essentially be part of the continuing bank rescue. 鈥淭he banks have significant exposure,鈥� says Mr. Rosen.
To help free up money for commercial real estate, the US Treasury and the Federal Reserve are expected to offer refinancing through a federal program called the Term Asset-backed Loan Facility (TALF) next month. TALF is already providing a backstop for securitized debt such as credit cards and auto loans.
Skyscrapers and pension funds
Yet the concern for the commercial real estate market goes beyond banks to the insurance companies and pension funds who have invested in real estate or made loans to real estate developers.
鈥淣ow, to some extent, there is the potential to spread the financial crisis to insurance companies and peoples鈥� pensions,鈥� says Jon Southard of CBRE Torto Wheaton Research, a real estate research company in Boston.
The impact of the current downturn is already being felt. The market for the packages of loans sold to investors, called Commercial Mortgage Backed Securities, has frozen completely since July. Now, even the highest-rated packages 鈥� for those ventures seen as having virtually no risk 鈥� are being marked down to produce a 11 to 12 percent interest rate.
The concern is that some large bank will be forced to sell its holdings, overwhelming the market, says Mr. Southard. 鈥淭he banks are not necessarily in this as a long-term holding,鈥� he adds.
With virtually no new loans available for new commercial buildings, 鈥渆verything is being postponed,鈥� says Rosen. 鈥淭here won鈥檛 be any new construction in 2010 or 2011.鈥�
Many of the problems for real estate moguls are being caused by the recession. With layoffs, firms are downsizing their office space needs. The national vacancy rate for offices at the end of 2008 was 14 percent, up from the recent low of 12.5 percent in the middle of 2007, Southard estimates.
鈥淏ut we think it will top 20 percent in 2011,鈥� he says. That would be an all-time high.
Lower rent prices?
As more office towers put out the 鈥淔or Rent鈥� signs, rents would likely fall. 鈥淲e expect double-digit declines over the next three years,鈥� Southard adds.
One example of how the market has worsened: Boston鈥檚 John Hancock Tower. Broadway Partners bought the iconic blue sliver of glass and steel for $1.3 billion in 2006. Today, based on rent and occupancy expectations for the Boston metro area, it may be worth as little as $575 million to $735 million, says Victor Calanog, director of research at Reis, a real estate advisory company in New York.
鈥淲hen the building was purchased, that was a good year at the time, and the price was reasonable 鈥� if the good years had lasted,鈥� says Mr. Calanog.
In Miami, rents in office towers are now down to 2003 levels, says Tere Blanca, president and CEO of Blanca Commercial Real Estate, Inc. The vacancy rate for office space is about 13 percent.
Empty shop windows at the mall
Problems are cropping up in shopping centers as well. Large regional malls had a 7.1 percent vacancy rate in the fourth quarter of 2008 鈥� the highest level since 2000, according to Reis. 鈥淭hey are in trouble because, for the first time in 17 years, the consumer has scaled back their spending,鈥� says Calanog of Reis.
When a mall operator loses a retail client, the effect may spread to other retailers in the same area.
鈥淓mpty stores in a mall deters shoppers just like it deters them in downturn areas if there is vacant space at street level,鈥� says Todd Sinai, an associate professor of real estate at the Wharton School at University of Pennsylvania in Philadelphia. 鈥淭hen if your retailers stop selling you cannot get new tenants.鈥�
In a few cases, mall operators are delinquent on their loans. The operator of the Promenade at Dos Lagos in Corona, Calif., has missed some payments. But Joshua Poag, president and CEO of Memphis-based Poag & McEwen which runs Corona, says by e-mail that the company is current with its eight other malls.
In fact, the delinquency rate on commercial mortgages is only 1 percent at this point.
鈥淭he problem is refinancing,鈥� says Rosen.
Opportunity among rubble
At least one debt-free real estate investor, the Gaedeke Group in Dallas, Texas, views the current situation as an opportunity.
鈥淲e are looking to buy assets,鈥� says Belinda Dabliz, vice president of leasing. 鈥淭here is a lot of debt coming due, and people have no way to restructure it.鈥�
But if the federal bailout doesn鈥檛 happen, 鈥渨e鈥檙e going to get a wave of delinquencies,鈥� says Rosen.
Does that mean real estate developers such as Mr. Trump or Mort Zuckerman 鈥� both living the lifestyles of the rich and famous 鈥� will be looking for help from the government?
鈥淭he great hope is that every player in affected markets will somehow survive the coming 鈥� or is it here already 鈥� storm,鈥� says Calanog. 鈥淭he difficulty is ensuring that players who behaved poorly 鈥� borrowed, lent, or paid too much 鈥� are also penalized, otherwise we run into the classic moral hazard problem.鈥�