Most of the readers of this article know that the residential real estate market more often than not serves as a harbinger for commercial real estate. By paying attention to the residential markets, it is often possible to predict, with reasonable accuracy, the state of the commercial markets 18 to 24 months out – this is both a curse and blessing. While commercial real estate professionals may have foresight as to what markets will be doing in two years, there is often not much that can be done to prevent what is coming. Good or bad, commercial real estate lags residential, which means that when residential markets begin their upswing, commercial real estate will too, just more slowly. The purpose of this white paper is to put forth a balanced discussion about some of the present happenings in the residential markets. It is my hope that doing so will stimulate thought and debate which will help you be better positioned for the future.
While I’d like to say that the residential market has hit bottom, and that things have begun to turn, I’m not sure that’s accurate. There is no doubt that some would argue that the residential markets have found there bottom, but there are clearly things happening which may drive the industry even farther into decline. The recent foreclosure freeze, being led by banks such as Bank of America, JPMorgan Chase, and Ally, may or may not help the markets. Most are saying that it will not and that it’s only a temporary fix. Either way, commercial real estate professionals need to be aware, proactive, and preparing for the ramifications of this event.
The fact that myriads of foreclosures are happening around the country is something that need not be discussed. What does need to be vetted though is that the foreclosure freeze has come about because of the rush banks were in to get paperwork through, which resulted in homes being wrongfully foreclosed on, even those who had gone through a loan modification. What’s worse is that the foreclosure freeze has brought home sales to a screeching halt once again. Distressed properties account for almost a third of the residential market and freezing these prevents thousands of people from buying and selling their homes. This is not good in a struggling market that needs an increase in commerce.
In addition to the banks halting the foreclosure process, attorney generals in all 50 states are now involved in the situation. Each state is wanting to protect their homeowners and requiring other lenders to get involved in the freeze. Although done through good intentions, requiring a freeze on foreclosures is only an artificial fix that will only produce short term results and could cause more damage in the long-run.
The worst part of the foreclosure freeze is that it has caused buyers to be skeptical of taking out loans on top of lenders raising loan requirements. Although the freeze is done out of a legitimate concern for their customers, it has cast another shadow on the already dark economic state. Many have stated that they feel this freeze will extend even further any hint of recovery.
So how does all of this affect the commercial real estate market? What does a residential foreclosure freeze and yet another hit on the lending industry mean for commercial real estate in the next couple of years? Well, commercial real estate is already feeling the crushing weight of this economy with almost $1.1 trillion in commercial loans and $211 billion in apartment loans being held by U.S. banks.1 All of this attention on the foreclosure process can only mean more attention on loan documents in the commercial real estate world. This has actually already started. In a recent study by PricewaterhouseCoopers LLP, 900 commercial real estate professionals were surveyed as to what they believe will happen with the overwhelming amount of special assets. The survey found that only 7% of those surveyed believe the current policy of simply extending loans to defer losses, otherwise known as “extend and pretend,” will continue in 2011. 63% of respondents believe loans will be modified or amended to put more assets back into performing status. The other 30% believe distressed assets will be foreclosed on or sold by borrowers.
These results show that much attention is already being given to the dire situation of commercial real estate. Professionals know that something needs to be done with all of the distressed assets on the market and soon. Banks have too many non-performing assets and they are gasping for liquidity. It is not my intent to make any judgments toward the political aspects of amending loans in order to jump start the monetization of non-performing assets. The intent is to look at the pros and cons of such actions. It’s important to discuss this issue as the latest foreclosure freeze is a heavy reminder of the fact that commercial real estate is in just as bad of shape, if not worse, and we cannot, as 63% of professionals believe, keep extending and pretending.
Amending loans, as PWC’s report has shown, is right around the corner. What are the benefits of modification and what are the downsides? Well, the first thing is that non-performing assets can, with a stroke of the pen, immediately begin generating operating income. Modification can also free an asset up to be sold, which also provides much needed liquidity. With this influx of cash, owners can begin to pursue other deals, giving a spark to their industry. Most people would agree that loan modifications are a viable tool, but they should only be used under specific circumstances. What circumstances entail a loan modification is another topic, but all that to say, amending loan documents is not an off-the-wall answer to the increasing trouble of non-performing commercial real estate assets.
The problem is, someone is still going to have to pay. Even with the adjustment of principles, it only serves to create an artificial solution. Debt doesn’t just vanish, and thinking that a loan modification erases it, is wrong thinking. The economy is going to absorb the non-payment and it’s not going be revived by artificial solutions. In addition, those who have been paying off their loans get no reward while those who are behind get an adjustment for being behind. Essentially, loan modifications reward wrong behavior.
Amending a loan is no small thing when the debt in question is large, as is the case with most commercial real estate loans. Actions such as government mandated loan modifications are part of the reason for the creation of the Tea Party and have been referred to as just another form of social engineering. Free-marketers argue that lenders should neither extend nor amend, but allow the realities of the market determine the outcome. If a property owner defaults, the asset should be foreclosed on, and the foreclosing party then remarkets the asset putting it back in play. This is the foundation for the argument against loan modification.
Whether you are a property owner, in good standing or not, a lender, or any professional in the commercial real estate industry, you need to be thinking about the possibility of a large, national issue, surrounding the foreclosure or loan modification/extension of commercial real estate properties. You must plan ahead, far ahead, during times like these.
Lastly, regardless of your feelings about the topic of this article, there is no reason to become passive in your efforts. There are many opportunities in commercial real estate. And, with loan modifications on the horizon, there is going to be a rush of distressed assets on the market. Banks are going to want to sell their properties before having to modify agreements on them. It may be wise to seek opportunities to grow in order to provide more liquidity. Nobody thinks that by doing nothing, they will somehow have the money they need to pay off debt. Everyone’s situation is unique, but everyone will be affected by a shift in policy to “extend and amend.” Do your research and consider your options. Don’t get caught off-guard by what is happening in the residential world. Be prepared.
Feel free to contact me with any questions you have about the changes up ahead and what options you have moving forward. My contact information is listed below.
About the Author:
Sperry Van Ness/Parke Group is a full-service real estate firm with over 30 years of experience focusing on brokerage, leasing, property management, facility maintenance, asset management, development and consulting. At Sperry Van Ness/Parke Group, it’s all about quality and customer service with our clients. Further, we provide concierge services, 24/7 emergency staffing, and unique solutions to your everyday needs that set us apart from the rest.
Contact Information:
Phone: 260.489.8500
Email: diana.parent@svn.com
Web: www.svnparkegroup.com
Twitter: @SVNParkeGroup
Copyright © 2010 | Sperry Van Ness / Parke Group This Office Independently Owned and Operated All information presented by Sperry Van Ness has been obtained from sources deemed reliable. Sperry Van Ness makes no representation with regard to the accuracy of the information contained herein.
1 Henry, D, & Levy, D. (2010). Commercial Mortgage Default Rate in U.S. More Than Doubles. Bloomberg Businessweek. Retrieved from http://www.businessweek.com/news/2010-02-24/commercial-mortgage-default-…
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