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U.S. commercial real estate could be next blow to economy
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08:43, July 30, 2009

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At an office building in a business district near Washington, D.C., a sign advertises commercial space for rent. Vacancies used to be snapped up quickly here, but the building manager said the sign has hung for months and no one has expressed interest in leasing the space.

Such is the scene in cities nationwide as commercial property prices continue to fall and the recession puts a damper on demand. Vacancies are rising as companies shrink, go out of business or close offices, experts said.

With property values unlikely to rise, banks are reluctant to offer refinancing deals to new building owners. Experts said that could ignite a wave of defaults on loans to developers of office buildings, condominiums and malls that could do further damage to the already ailing economy.

Commercial real estate prices slid 7.6 percent in May, according to the latest available statistics from Moody's Investors Service, and have dropped 35 percent from their peak in October 2007.

Hardest hit are commercial properties in New York City, but other cities including Detroit, Phoenix, Dallas, Las Vegas, Chicago, Boston and Los Angeles are also faring poorly. Particularly hard hit have been retail properties and hotels, experts said.

At a recent Congressional Oversight Panel hearing, Richard Parkus, an analyst at Deutsche Bank, said two-thirds of commercial real estate loans -- which amounts to hundreds of billions of dollars -- could be in default in the next few years.

At the same hearing, Jeffrey DeBoer, president of Real Estate Roundtable, a trade organization in Washington, D.C., said the problem could impact thousands of jobs in construction and real estate.

His group estimates that around 400 billion dollars a year in commercial loans will require refinancing during the next ten years.

At a recent congressional Joint Economic Committee hearing, Chairwoman Carolyn Malony, D-N.Y., called the commercial real estate market a "time bomb" that could spur a second wave of losses at banks and force shopping center and hotel owners to declare bankruptcy. The problem could also stymie economic recovery, she said.

Banks' response has been sluggish, experts said, adding that their reluctance to lend is contributing to the increase in the number of delinquent properties.

Ben Carliner, director of research at the Economic Strategy Institute, a Washington, D.C. think tank, said prices will slide even further. As factories and offices close and staff are laid off, demand for commercial real estate will continue to decline.

Valued at about 6.7 trillion dollars, commercial real estate comprises 13 percent of the United State's gross domestic product and further price declines could impact the larger economy, experts said.

Carliner said the effect on banks -- particularly local and regional ones that have thus far escaped the worst of the crisis --will be significant. Many smaller banks were pushed out of home mortgage and credit card markets by large financial institutions and a few big banks, he said. As a result, small banks began to focus on real estate loans, he said.

If bad commercial real estate loans hurt banks enough, some will have to be reorganized or sold off and liquidated, Carliner said.

The Fed and the Treasury will be watching closely to assess whether the crisis spreads to the large, systemically important banks. But while the government might choose to tweak some policies, any major initiatives are unlikely, he said.

Robert Bach, senior vice president and chief economist at Grubb& Ellis, a real estate investment and services company, said commercial real estate will be a problem, but not one as dire as the home mortgage bubble that burst last year and sent the economy reeling.

"It's not the threat to global financial stability that the housing market proved to be last year," he said.

Still he expects prices to decline by another 15 percent, which will put total losses at 45 to 50 percent once the smoke clears and the market hits bottom around 2010 -- the year many experts are batting around.

Prices will continue to languish through 2011 and begin rising around 2012, he said. Parkus echoed such sentiments when he testified at the Congressional Oversight Panel that the market will not bottom out for several years and will see no improvement until at least 2012.

Carliner said the only way to repair the excess capacity problem is to allow market forces to weed out the less desirable properties through price declines and bankruptcies.

Barry Bosworth, senior fellow at the Brookings Institution, a Washington, D.C. think tank, said prices will continue to decline over the next year but added that "these cycles are common in history and the price declines (will) continue until the excess capacity is eliminated."

"The solution is to simply wait it out until demand and supply are again in balance," he said. "Demand (for commercial property) depends on the state of the overall economy."

The Federal Reserve, however, is taking initiatives to ameliorate the damage before it snowballs. The Fed aims to jump start the market by expanding its Term Asset-Backed Securities Loan Facility -- a program that will enable the Fed to lend up to 1 trillion dollars to certain parties.

Maloney said the Public Private Investment Program -- an initiative providing liquidity for so-called "toxic assets" on the books of financial institutions -- could also help correct the problem.

But she added that the program expires at year's end -- which may limit its impact -- and that uncertainty over its future has kept many investors on the sidelines.


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