Let me begin by saying that I think Commercial Real Estate (“CRE”) is going to take a big hit – I think it’s going to be at least as bad as the early 1990’s and it could easily be worse. My pulse quickens and my adrenaline starts pumping every time I see a subject line in my Google Reader proclaiming it’s here. That happens almost every day now (for example, Housing Wire, Calculated Risk, and Deal Junkie). But, delinquency rates for CMBS loans are practically nil (Deal Junkie again). What’s going on?
When I think CRE bust, I think of significant declines in the value of multifamily, office, industrial, retail, and lodging properties, accompanied by increasing delinquencies and foreclosures for these properties. There is some evidence values are declining modestly, and fundamentals (occupancy and rent levels) are starting to deteriorate, especially in the retail, lodging, and office sectors. But, there are no data to show we are remotely at bust levels in actual performance. When people are talking about being in a bust, they are talking about other things:
- Declines in Architectural Billings. This index is way down (see Housing Wire). That’s evidence there are fewer new projects in the pipeline. This is obviously bad for architects, contractors, and others whose livelihood depends on new projects, but it’s good for everyone who owns or has a loan on a project already under way or completed (now is not the time for more additions to supply). I would call this evidence of a new construction bust, but not a CRE bust.
- Declines in Environmental Site Assessments (ESAs). Fewer ESAs are being conducted (Housing Wire again). An ESA is done when CRE is financed or sold, so this is a symptom fewer financing and sale transactions are happening. Fewer transactions is bad for ESA providers, brokers, loan officers, title companies, and others who make their living from transactions, but in and of itself it’s not bad for CRE owners or lenders.
- Lower Demand For, and Tighter Lending Standards and Higher Pricing on CRE Loans. Demand for CRE loans is down, pricing is up, and lending standards are tighter for CRE loans (see Calculated Risk). These are all indicators of less CRE lending, but are not symptomatic of weakness in CRE itself. A CRE Lending bust, yes, a CRE bust, no.
- Increase in Commercial Real Estate Delinquency Rates. The Fed reports CRE delinquency rates were at 4.73% for third quarter 2008, the highest level since 1994 (Calculated Risk again). The problem with this number is the Federal Reserve definition for CRE is so broad it’s almost useless - “Commercial real estate loans include construction and land development loans, loans secured by multifamily residences, and loans secured by nonfarm, nonresidential real estate, booked in domestic offices only” (Federal Reserve Charge-off and Delinquency Rates Statistical Release). Similarly, the FDIC says “commercial real estate (CRE) loans are exposures secured by raw land, land development and construction (including 1-4 family residential construction), multi-family property, and non-farm nonresidential property where the primary or a significant source of repayment is derived from rental income associated with the property” (FDIC CRE Guidance). When you dig into the call reports, it quickly becomes apparent the problems are in single family land and single family construction and development loans, and not in what most of us consider CRE (multifamily, office, retail, industrial, lodging). Call it what it is, please - a residential land and construction bust.
Again, I think CRE (as most of us think about it) is going to have real issues the next few years. But, we’re not there yet.
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