Coming Commercial Real Estate Crisis

Boston’s Hancock Tower is a sad tale of how one commercial real estate complex ate over one billion dollars in a very short time frame.

But that’s exactly what happened with the 62-story building, as ownership changed hands four times in six years. In January 2009, an aggressive young commercial real estate operator defaulted on a portion of the building’s $1.3 billion mortgage just 24 months after buying it. In March, two firms that had purchased chunks of the tower’s second mortgage for pennies on the dollar assumed control, essentially rendering up to $400 million of debt worthless. The Hancock’s market value is now about $700 million. That is only about half of what it appraised for less than two years ago.

The story of Boston’s Hancock Tower is hardly unique as the recession/depression finally spilled over into the commercial real estate market in 2008. With the national average vacancy rate now averaging 15% and climbing conditions are set to become disastrously worse. Many existing tenants are requesting reductions in rents and threaten to move out if building owners do not comply while others default on rent payments and eventually close their businesses.

Those investors who think that the worse is over for the nations economy should consider the following:

The nation’s banks have about $1.5 trillion of commercial real estate loans on their books. According to the Federal Deposit Insurance Corp., whose troubled bank list has expanded to 416 from 90 in March 2008, the value of real estate loans on which borrowers were more than 90 days or more past due spiked to $67.3 billion in the first quarter of 2009 from about $13 billion in the second quarter of 2007. In the coming months, the recovering banking industry will probably report billions of dollars in losses tied to commercial real estate loans.

During the boom times of 2006 – 2008 commercial real estate mortgages were securitized much like the subprime residential mortgages. Therefore the infection of mortgages gone bad is not limited to only the banks and lenders that originated the mortgages. Just as with the subprime mortgages there are plenty of hedge funds, insurance companies, regional banks, and private investors who have exposure to these commercial toxic assets.

We are only in a bounce moment of a more serious depression to come. The next down phase could well be triggered by a crisis in commercial real estate. If you live in a major city just look around you. The number of “for rent” and “space available” signs is probably valid advertising for the soon to come crisis.