Commercial Real Estate ... The Next Time Bomb?

» NYT: As Vacant Office Space Grows, So Does Lenders' Crisis

I'm not sure whether the photo of Houston's MainPlace construction is to be considered ominous or defiant in terms of the article. Whatever the case, I'm at least a bit hopeful that the population and foot traffic downtown are enough to keep the Books-a-Million store going. I just can't fathom another hiatus without a real downtown bookstore (and for the record, I'm considering the old Crown Books a "real" store and totally ignoring the presence of the chain store in the mall).

Just as home loans were pooled, then carved up and sold to investors as securities over the last two decades, commercial property loans were repackaged for the financial markets. In 2006 and 2007, nearly 60 percent of commercial property loans were turned into securities, according to Trepp, a research firm that tracks mortgage-backed securities.

Now that the market for those securities has dried up, borrowers cannot easily roll over the loans that are coming due.

Many commercial property owners will face a dilemma similar to that of today's homeowners who cannot easily get mortgage relief because their loans were sliced and sold to many different parties. There often is not a single entity with whom to negotiate, because investors have different interests.

By many accounts, building owners have been caught off guard by how quickly the market has deteriorated in recent weeks.

Rising vacancy rates were expected in Orange County, Calif., a center of the subprime mortgage crisis, and New York, where the now shrinking financial industry dominates office space. But vacancies are also suddenly climbing in Houston and Dallas, which had been shielded from the economic downturn until recently by skyrocketing oil prices and expanding energy businesses. In Chicago, brokers say demand has dried up just as new office towers are nearing completion.

"The economic recession is so widespread that we believe virtually every market in the country will see a rise in vacancy rates of between 2 and 5 percentage points by mid-2009," said Bill Goade, chief executive of CresaPartners, which advises corporations on leasing and buying office space.

There's a certain disconnect in trying to understand how a modest 2-5 percent rise in vacancy rates would really blow up a few more banks. But just as the case with residential mortgages, the biggest factor isn't the defaults or slowed growth ... it's the fact that the securitization of loans has been largely under-regulated (if not un-regulated). For a somewhat deeper read on the topic, there's Joe Nocera's NYT Magazine cover story from Sunday (which I still have to get around to reading in full) and a 3-parter by the Washington Post on AIG.