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Strategies & Market Trends : The Residential Real Estate Crash Index -- Ignore unavailable to you. Want to Upgrade?

To: Skeeter Bug who wrote (211753)	7/22/2009 1:16:01 PM
From: MulhollandDrive	Read Replies (1) \| Respond to of 306849

Wednesday, July 22. 2009 Posted by Karl Denninger in Macro Economics at 12:57 Commercial R/E: Tick... tick... BOOM! "This time it's different" The state of commercial real estate was one of the most- asked-about subjects in questioning by lawmakers so far in Bernanke’s two days of testimony on the economy. Bernanke said today in the Senate and yesterday at the House Financial Services Committee that it’s too early to tell how effective the Fed’s main initiative in the area will be. As I have pointed out repeatedly for more than two years commercial real estate tends to lag residential in economic downturns by 12-18 months in terms of severity, and sometimes as much as by two years or more. This was to my decided advantage in the mid-90s recession when I glommed onto about 8,000 square feet of space in Two Prudential Plaza for an absolutely unbelievable price (about 1/4 of the "going rate" for Class A space) on a five-year lease. Why? Because Donnelly had literally walked off on it, leaving cube systems and both data and voice wiring, along with a decent amount of office furniture, still in place! The building had quite a bit of empty space and needed to fix that fast. I had a fast-growing business and needed more space fast. Nice fit eh? Well, this time is much worse than the early 90s. We had a monstrous residential real estate bubble and both the lending and rent rates on CRE went bananas to the upside during the mid 2000s. I saw it and just shook my head - and what's worse, they're still building in parts of this country, including right here where I live, despite businesses going under left and right. The overcapacity problem is extraordinarily severe. Regional banks are up to their necks in this paper, and its performance is becoming worse by the day. "FOR LEASE" signs have sprouted like mushrooms, and this will continue. The unfortunate reality is that a lot of these developments cannot possibly ever perform as originally structured, as the cap rates are off with reality to a degree that is impossible to reconcile. These buildings and malls will never be profitable outside of "huge bubble" conditions, and those are not coming back! To make it worse the customary financing for commercial real estate, unlike many home mortgages, does not wind up with a clean title. Instead it is more of a "rolling cash flow" scheme where loans are refunded every few years and the owner of the property earns out construction and interest cost on the spread. The problem with this sort of financing is that it relies on ever-improving (or at least stable) business conditions in order to remain stable in the marketplace; a downturn of any severity kills you dead by either killing your cash flow or putting you into a situation where you can't roll the paper at the appointed time at anything approaching a reasonable set of terms. I fully expect commerical real estate to be at least as bad in terms of severity as residential and it may be worse due to the insane leverage that is usually employed. This will destroy many regional banks (it already has figured prominently in almost all of the bank failures thus far) and anyone who thinks that we will "come out of recession" while there is quite literally another $2-3 trillion worth of bad commercial real estate deals on the books that cannot be refinanced or cleared is simply out of their minds. What you've seen thus far is just the leading edge of this tsunami starting to curl over; picking up fish under such conditions is not the recommended course of action. market-ticker.org!.html