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REVIEW SUMMARY
Industry. Commercial real estate
Trend. Rising foreclosures
Key. Commercial foreclosures threaten to flood the market and push values down further.
If you're feeling sorry for yourself, consider attending a gathering of commercial real estate brokers.
“Not every property is distressed, but every owner is distressed,” quipped Lee Arnold, the chairman and chief executive officer of Arnold Cos., parent of brokerage Colliers Arnold. He was one of a dozen experts speaking at the CCIM Real Estate Outlook Conference in Bonita Springs on Jan. 28.
Many banks are not ready for what most brokers say will be an onslaught of commercial real estate foreclosures.
“It's like we're drinking from a fire hose they're coming in so fast,” says Anthony Martin, a vice president with Wachovia who is helping the bank manage distressed commercial real estate. Wachovia is now a part of Wells Fargo.
Martin says colleagues at some rival banks didn't realize the magnitude of the problem. “They weren't ready for this,” he says.
Randy Anderson, an economist who specializes in real estate at the University of Central Florida, says a downturn in commercial real estate could drag the U.S. economy back into recession. That's because there is $1.8 trillion of commercial debt maturing in the next few years and the credit markets remain largely frozen.
Anderson says mortgage delinquencies on commercial properties could grow to 15% to 20% of loans from just 3% in the second quarter of 2009. It's a myth that banks were more careful when they lent money to commercial developers.
Striking a somewhat ominous note, he says: “We underwrote more aggressively than on the residential side.”
The onslaught of distressed properties is going to continue to push values down as owners give them up for pennies on the dollar. “Something's got to happen to those buildings,” Anderson says.
“It's a serious problem for banks,” says Martin. “In this market, it's just not getting any better. Your first offer may be your best offer.”
Commercial real estate lending is the bread-and-butter business of community banks in Florida.
“The local and regional banks are going to be most affected by this crisis,” says Stephen Cunningham, managing partner with LandQwest Commercial and LandQwest Asset Recovery in Fort Myers.
One bad omen is the fact that the Federal Deposit Insurance Corp. recently opened an office in Jacksonville to deal with problem banks in the state.
“They've hired 1,000 people in Jacksonville,” Anderson says. “There's a lot of hurt coming.”
No more pretending
Banks that hold commercial mortgages on distressed properties have avoided taking foreclosure action against struggling property owners, hoping the economy would recover and they would not incur the costs of owning the property.
Taking properties means banks have to mark down the value of their assets and account for those losses, hitting their bottom line and requiring them to set aside or raise more capital. What's more, doing so reflects poorly on the bank officers who approved the loans and are now busy managing borrowers in difficult straights.
Fact is, some community banks face closure if they write down commercial real estate to their current values because they would take such an overwhelming hit to their capital. Arnold calls these banks the “walking dead.”
Still, government regulators are going to start forcing banks to take action against distressed owners, warns Robin Webb, vice president for statewide operations with Coldwell Banker Commercial NRT.
Making matters worse, many larger commercial projects were financed through loan syndicates involving several banks and none wants to be responsible for the underwriting mistakes.
“Those processes are still not sorted out,” Webb says.
While residential foreclosures can take up to a year to resolve through the clogged courts, commercial real estate foreclosures can take as long as two years.
“That legal expense has gotten to be a real impediment,” says Arnold.
Some banks are avoiding the foreclosure process by trying to sell the loans, but doing so means financial institutions lose all recourse against the borrower.
“They try to squeeze as much out of borrowers as they can,” says Martin. “They're still thinking about saving that note.”
Brokers seek bank listings
Commercial real estate brokers and banks are playing a sort of Kabuki dance that both sides know will result in no sale.
In a hypothetical but typical example, Cunningham says a bank that lent $3 million on a commercial building that's now worth $1 million will ask a broker to list the property at $2 million because the bank officer doesn't want to lose his job because of the bad loan he made. Meanwhile, the broker agrees to list the property for $2 million to maintain the business relationship with the bank, even though he knows the building won't sell for that lofty price.
In most of Florida, listing properties with brokers rather than auctioning properties is the best way to dispose of properties. Martin says he hasn't seen any data to suggest that auctions are a better way to sell commercial properties.
Except for the Panhandle, “auctions really haven't shown a lot of success in other parts of Florida,” Martin says.
Martin says banks such as Wachovia are realizing that they need to sell properties and ther first offer may often be the best one. He says brokers are cold-calling him to pitch him their services. “I get 15 calls an hour,” Martin says. “I don't have time for those calls.”
Martin's advice for brokers who want his and other bankers' business is to identify disposition solutions for specific properties. “We're overloaded,” he says.
Indeed, the last option any bank would choose is to take possession of the deed to a commercial property. That's one of the reasons the commercial real estate market hasn't yet been flooded with foreclosures, brokers say.
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