A significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American. Empty office complexes, hotels, and retail stores could lead directly to lost jobs. Foreclosures on apartment complexes could push families out of their residences, even if they had never missed a rent payment. Banks that suffer, or are afraid of suffering, commercial mortgage losses could grow even more reluctant to lend, which could in turn further reduce access to credit for more businesses and families and accelerate a negative economic cycle.
— Text of a letter sent Feb. 18 by U.S. Rep. Paul Kanjorksi to the leaders of the Office of Thrift Supervision, the Office of the Comptroller of the Currency, the National Credit Union Association, and the Federal Deposit Insurance Corporation.
How — if at all — will the growing instability in the commercial real estate (CRE) market affect CRE in northeastern Pennsylvania? We asked those in the trenches.
According to a recent report by the Congressional Oversight Panel, about $1.4 trillion in CRE loans will reach the end of their terms between now and 2014 and about half of these mortgages are currently underwater as property values have declined and continue to do so. The report estimates that losses at banks alone could range as high as $200 to $300 billion.
Recently, U.S. Rep. Paul Kanjorski (D-Pa. 11), chair of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, and Congressman Ken Calvert (R-Calif.) sent a letter highlighting this report and asking financial regulators to work together to minimize the impact of this ever more unstable CRE market.
Part of the bipartisan letter, sent to the leaders of the Office of Thrift Supervision, the Office of the Comptroller of the Currency, the National Credit Union Association, and the Federal Deposit Insurance Corporation, asks regulators to take the following steps:
- Establish a clear method for measuring and evaluating the effectiveness of recent CRE loan modification guidance issued by the regulators;
- Institute metrics to more clearly differential performing versus non-performing loans as well as any other steps that provide lending institutions with more confidence in assessing CRE loans;
- Make clear public statements encouraging lenders to continue to make credit available for performing assets as a means of restoring confidence and long-term value in the CRE market.
“I applaud Congressman Kanjorski’s efforts and hope that this bipartisan effort is taken seriously,” says Michael Baxter, broker and owner of Michael Baxter & Associates Commercial Real Estate and Property Management. “Something has to be done now to encourage lenders to work with the business community to help them through the current economic conditions rather than making the problem worse by refusing to make new loans and/or modifying existing, performing loans.
“My biggest concern is that these efforts will be ignored or we will over-debate the methods of handling the problem and accomplish little in the process,” said Baxter. “This has to truly be a bipartisan effort and everyone’s cooperation will be needed to prevent this situation from slowing down or even reversing our economic recovery.”
Baxter says his firm has been following this issue for some time and said he cannot think of another issue that more directly affects CRE.
Though experiencing greater activity from potential buyers and noting there are plenty of sellers, he said his office is spending more time than ever looking for lenders that will finance projects and businesses that make sense.
“We need lenders to boost our confidence by easing up on small business owners and helping businesses survive and retain jobs. They also need to be much more aggressive with new commercial loans that will stimulate the economy and create new jobs,” said Baxter. “It is critical that something is done now.”
Before anything gets done, John Cognetti, president of Hinerfeld Commercial Realty, says a basic understanding of the commercial real estate market and the various markets and submarkets is key (see “CRE Briefing” on next page).
Cognetti says it’s important to know that certain types of markets are regional and not county-bound or even state-bound, and then to segregate them.
He says the NEPA industrial market, which is regional, is uncertain.
“We all have the big boxes here in all the communities,” he said. “Then we have the malls, the strip centers, and such, shopping centers with supermarkets, which tend to do well because supermarkets are doing well, as are the dollar stores. The people that are hurting right now,” said Cognetti, “are a lot of the smaller, independent Mom ‘n’ Pop stores. Sometimes they have the resiliency if they’ve been in business long enough but you don’t see as many startups only because, again, the consumer is not spending money.
“Our people in northeastern Pennsylvania have always been more on the frugal side in spending, but when they did have more and more wealth, they’d spend it. However, now that’s slowed down. The other thing for office space and for retail space — you don’t see a lot of new business formations right now because many people have been let go, companies are shrinking their staffs, and there are very few new businesses like we had say four or five years ago.”
Cognetti said in the industrial/rental market, the warehouse distribution area, Hinerfeld and others are seeing their rates being undercut by other markets. The industrial market encompasses all of eastern Pennsylvania and New Jersey.
“We are in the northern point of the 1-80 corridor and the other areas lower than us, Lehigh Valley, Harrisburg, York, seem to have a little bit more activity than we’ve had of late and in the last year. Some their rates are lower than ours.
“But the most interesting thing that has happened is with the abundance of industrial vacancy in New Jersey, which is people are choosing to stay in New Jersey instead of moving to Pennsylvania because it’s cheaper.”
The retail market has the enclosed malls in Scranton, Wilkes-Barre and Hazleton. Power centers, strip centers, lifestyle centers exist in Lackawanna and Luzerne counties with miniature versions in the other markets. Highway commercial, suburban and urban retail plus small strips are throughout the region.
In northeastern Pennsylvania, the office market is fairly flat,” he said, but notes it has never been a growth market here. “There may be a few buildings that people have overpaid for that you read about — and maybe they are foreclosed or whatever — but, by and large, there’s not a tremendous amount of vacancy in buildings.
“The tendency, if there is vacancy, because they are older buildings, people just haven’t kept them up. The prices have actually come down, so a lot of people are trading up in renting and businesses that are doing well can get better quality space at a lesser cost than they could have before.”
“What has to happen though for the market to correct itself, which we are seeing with our clients, is that our rates now have to come down. Our rates have to be more competitive with other areas, otherwise we just don’t get the interest. The other thing is: There’s so much property available, say, in New Jersey, that people are just gravitating to getting a better building at the same price than getting an older building, or even a lesser price, and an older building here in NEPA, than a newer building someplace else.
“(Kanjorski’s letter) speaks to a lot of different levels,” he said. “He is talking about the fact that there are many people that may not be able to get financing for these transactions like they did before. That is a concern.”
“(But much of the current CRE troubles) have to do with the different types of lending that occurred for these large commercial properties — commercial mortgage backed securities — and a lot of the lending that was done,” said Cognetti. Many, he said, are short-term notes — five years in duration — and are coming due. This, said Cognetti, would primarily affect shopping centers, some of the lifestyle centers and such.
“Their values have gone down to maybe less than what their mortgage amount is, so the big question is: What are the banks going to do? Some people may get wiped out,” he said, “but, what’s also happening at the same time is that people are likely realizing — especially if there are tenants in the buildings that mortgage covers — that they are still generating a cash flow. So the values may drop,” he said, “and someone else may come along and buy at the lower value. It’s a big shakeout and another significant loss for the lenders.”
Cognetti says there are loans available, but borrowers can’t borrow when there is no business. The other problem is there are no jobs. On top of that, with so few sales completed, getting an adequate appraisal on a property is challenging.
“The question is: When is the value of real estate going to come back? No one can predict that. The pricing, they say, is off about 40 percent — it declined 40 percent in 2008.”
Asked if commercial real estate in the U.S. is heading down the same path as Big Banking, Cognetti said, “It could.”
“The northeast Pennsylvania economy is never boom nor bust, so while national trends affect us, with a few exceptions, they are not as severe,” he said, “However, this time it could be different.”
