Commercial Real Estate Outlook

The real estate market has serious problems.  We looked at this yesterday while focusing on residential.   Do you think Commercial Real estate markets might have similar problems?  Yes, but they are slightly different.  Commercial loans are not currently guaranteed by the US Government the way Residential mortgages are.  Therefore, banks do not typically give 30 year loans on these properties.  The loans are usually for 7 years and then must be refinanced.

The problem is that investors and bankers got euphoric in the mid 2000’s and began reaching on property valuations.  They bought at peak rates assuming the market would continue going up without pause.  And they did all this at incredibly low interest rates.

So the same potential time bomb of rising interest rates that exists for residential real estate also exists for commercial.  However, there are some different issues at play here that don’t affect most home mortgages which are long term and fixed with a note payer who will pay this note above all others.

Because the economy has soured, most commercial properties no longer enjoy the same revenue that they did in earlier years.  Thus the income no longer supports the high valuations that were previously established and borrowed upon.  This results in borrowers having little, no, or negative equity in these properties.  Because banks are looking for the borrower to have his own equity in the property, this is a serious problem!  We’ve had systematic over leveraging in our economy and society and borrowers don’t have the extra capital to put into these properties.  As these notes come due, the borrower will not be able to refinance the note due to this lack of equity.  Neither will upside down borrowers be able to sell without going bankrupt.

Thus it appears that many, many commercial properties will be foreclosed upon.  However, it would not shock us to see the Federal Government step in and offer government guarantees on commercial notes as they currently do for residential.  This is not a sound practice and moves us ever deeper into communism.  However, the politicians in Washington will see two options.  A massive depression, or another bailout.  They choose the bailout every time and thus we wouldn’t be surprised to see that here.  However, this would be unprecedented and so we also wouldn’t bet on this happening.

All in all, real estate markets must go much lower before all the rot in the system from the government-designed boom has been eradicated.  Only then will prices stabilize and have the opportunity to appreciate.  That being said, real estate is real property and in the case of hyperinflation, a piece of real estate should hold its value far better than many other asset classes over the long haul.  (But it might be a very painful long haul and many will be forced to sell before that day comes.)

You might have also come to the correct conclusion that all these problems in real estate will be devastating to banks.  Many of our problems today are circular and this is no exception.  Can you think of any way out of this?

This is Part 5 in the series Economic Depression. To continue with this series, click on Pt 6. To use this as a growth tool to better understand your own calling, please read Part 1, Pt 2, Pt 3 and Pt 4.

Photo credit: hanneorla

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