Commercial market to infect housing?

The problems in the real estate sector are beginning to look like a bad flu epidemic that just keeps circling the globe and returning to infect those who have already suffered the virus.

Back in 2007, subprime mortgages deflated and an ensuing credit crisis gripped the banking sector. Immediately, the residential real estate bubble collapsed and home values decimated, dropping as much as 50 percent in particularly hard-hit cities.

What at first seemed to be strictly a residential real estate problem by 2008 crossed species into the commercial real estate sector. Whether one accumulated office buildings, hotels, shopping centers or apartments, the story was the same: Vacancy rates were climbing and lease rates dropping like a stone. Commercial buildings that have changed hands in the past year have done so at valuations sometimes less than half that experienced at the peak of market just two years before.

However, due to such factors as long lease rates, billions of dollars in assets securitized into commercial mortgage-backed securities and a banking sector that has been reluctant to confront valuation declines, the commercial real estate marketplace has been on a slow pace of rectification. That should all change in 2010.

The problems in commercial real estate seem to be approaching a tipping point, which means the banking system will have to address these problems in the coming months. And that, some folks predict, will have a second-round, return impact on the residential real estate market.

The question is, will this viral infection be more of the same bad news for investors or will immune systems in the banking systems finally be able to transform the trend lines into something more salutary?

Lesley Deutch, vice president of John Burns Real Estate Consulting and head of its Florida office in West Palm Beach, has been an industry Cassandra trying to get the residential sector to wake up to the fact that commercial real estate distress will have a "big" impact on housing.

According to Deutch, commercial real estate property values are now down 35 percent from peak and are expected to fall even more as leases expire and existing tenants either vacate space or renew their lease at lower rates. This is particularly troublesome for the major banks, which own nearly 45 percent of all the commercial mortgage debt outstanding. In comparison, banks own only 21 percent of single-family mortgage debt outstanding -- and that lower percentage has tied lenders up in knots for the past three years.

Deutch, for all her prescience, is not sure which way it will turn out for residential real estate. Her biggest fear is that those banks with high commercial real estate exposure may just simply squeeze down lending for all property types in all segments of the market. ...CONTINUED

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