Anchorage Daily News

Commercial real estate in the Lower 48 is in serious trouble and will end up being the nation's hardest hit industry outside the auto industry, predicts Lawrence Yun, chief economist for the National Association of Realtors in a recent press release.

The following is drawn from a number of commercial reports and primarily from a commentary issued by the National Association of Realtors in May, written by research economist George Ratiu.

Commercial real estate is being hammered on several fronts. Lower consumer demand, higher vacancies, lower incomes, maturing loans and lack of financing are all coming together in a perfect storm.

The major provider of larger commercial real estate loans during the past 25 years has been "commercial mortgage backed securities," or CMBS. These are financing vehicles in which a lender pools various mortgages, slices them up and sells the pieces to investors with different levels of risk tolerance.

CMBS lending has grown tremendously. In 1992, $14 billion was issued. That had grown to $230 billion in 2007. Globally, the United States accounts for about 70 percent of CMBS lending worldwide, with an estimated market value of $670 billion.

Those loans have maturities that require the loans be paid off before full amortization. Unlike a house loan, where the loan continues until paid off, a commercial loan has monthly payments based on long-term amortization but with a requirement to pay the loan off generally after 5 to 10 years. This is a "call" or "balloon payment" and means there is a loan balance at the call date. Borrowers pay off the loan balance by getting a new loan.

Before the current crises, obtaining a new loan was not a problem. The combination of ample financing being available, paydown of the loan principal and an increase in the property's value provided enough owner equity for the new loan.

But getting a new loan now can be impossible. Many CMBS loans had skimpy down payments, so the original loan amount was a large portion of the property's value. Some loans have short-term call dates. With all the problems in the commercial market, the properties may be worth less than the loan amount now because of the proportionally high original loan amounts, more vacancies, lower rents and higher interest rates. Plus lenders, if one can be found, want a bigger down payment and are charging higher interest rates.

For example, five years ago a $50 million property might have a CMBS loan of 90 percent. This would be a $45 million loan financed at, say, 6 percent, with 25-year amortization and a call date in five years. The owner by now would have a loan balance of $42 million, which would be due because of the call date. But if the property value fell 10 percent and banks are now lending only 60 percent of the building's value, then the most the owner could borrow would be $27 million -- $15 million short of the amount needed to pay off the called loan. If the call is not paid on time, the borrower is delinquent on the loan.

This can be devastating and recently caused one of the largest real estate collapses in U.S. history. The second-largest shopping mall operator in the world, General Growth Properties with 200 U.S. malls, was unable to restructure $27 billion in debt. The company went bankrupt last month.

There is a wave of upcoming CMBS maturities to be reckoned with. This year has $410 billion in CMBS maturities; in 2010, $310 billion; in 2011, $500 billion; and in 2012, $1.5 trillion.

This totals $2.3 trillion.

Lenders are temporarily dealing with this by extending the call dates in hope that the financing market will improve. Also, the Federal Reserve Bank has a lending program for commercial loans with five-year calls, but this program has only $100 billion available. These are at best stopgap measures.

The solution is for the economy to recover and credit markets to begin working again, so these loans can be refinanced. But commercial real estate lags the economy. Even if the economy starts to recover later this year, commercial real estate will not start recovering until well after then.

It looks like CMBS will continue to be a major problem and one we are going to hear a lot more about.

Chris Stephens, CCIM, is a local associate broker specializing in commercial and investment real estate. His opinion column appears every fourth Sunday.

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