Implications of Commercial Real Estate Collapse

Hidden in the headline U.S. Housing Crash Deepens in 2008 After Record Drop is the fact that it's not just housing we are talking about.

Everyone from mortgage-finance company Fannie Mae to Lehman Brothers Holdings Inc. expects declines next year. Existing home sales will drop 12 percent and existing home prices will fall 4.5 percent, Washington-based Fannie Mae says. Lehman analysts estimate almost 1 million mortgage loans will default in 2008, up from about 300,000 this year.

"We're only halfway through the housing shock," said Ethan Harris, chief U.S. economist at New York-based Lehman, the fourth- biggest U.S. securities firm by market value. "It's just a matter of time before the weakness spreads to the rest of the economy."

My Comment: It's already spread. You can see it in rising credit card delinquencies and a slump in holiday sales. See Recession Proof Holiday Sales for more about consumer spending.

U.S. office sales fell 70 percent in October from a year ago, industrial sales declined 24 percent, and retail and apartment sales dropped 50, according to New York-based research firm Real Capital Analytics Inc. The declines are the biggest since the company began keeping records in 2001.

My Comment: Take a good hard look at those numbers. We have yet to see the fallout from them. When it comes it will not be pretty. How can firms hire if they are not building stores or opening up new offices? Why would they want to hire now anyway? Unemployment is poised to skyrocket.

Coldwell Banker's Gillespie said demographic and economic changes, such as rising immigration and employment, will help boost home sales. "People buy for lifestyle, and there's a lot of pent-up demand out there," Gillespie said.

My comment: Gillespie could not possibly be more wrong about employment, lifestyles, or pent-up demand. For more on the latter please see Pent Up Housing Demand In Pictures.

"You're not seeing the Equity Office transactions anymore," said Dan Fasulo, Real Capital's managing director for research. "It's extremely difficult right now to finance the large portfolio transaction and privatizations we've seen over the last couple of years. I can't even think of one major privatization that has been announced since the credit crunch."

My Comment: Blackstone marked the top in commercial real estate insanity.

Mission West Properties Inc., owner of almost 8 million square feet of Silicon Valley commercial buildings, disclosed talks in July with a private equity firm about being acquired. The Cupertino, California-based company said a month later the sale might fail after a bank withdrew funding.

My Comment: Watch for more withdrawn funding. Any project that has not yet broken ground may not break ground for years.

Highwoods Properties Inc., the owner of almost 34 million square feet of commercial space, said last month that it no longer expects to sell properties in Winston-Salem, North Carolina, totaling 1.6 million square feet. The company cited "volatility of the capital markets" as the reason the sale didn't go through.

My Comment: We have not yet begun to see volatility.

"I know we weren't predicting things would get this bad," said Frank Liantonio, executive vice president for global capital markets at New York-based Cushman & Wakefield Inc., the largest closely held real estate services provider. "There were some signs there, but I don't think anyone anticipated the level of dislocation that was actually created."

My Comment: Obviously they are not reading my blog or Minyanville.

Trouble In Texas: Huge Multifamily Owner Nears Collapse

Apartment Giant MBS Cos. Goes Deep in Arrears on More Than $600 Million in Loans.

MBS Cos., one of the largest multifamily property owners in the country, is delinquent, in default or in danger of becoming so, on more than $900 million in loans. For Michael B. Smuck (the MBS in the company name), that means he is in danger of seeing his apartment empire dissipate for the second time in his nearly 30-year real estate career.

Based in the New Orleans area, MBS Cos. owns and operates more than 65 apartment complexes totaling about 17,000 units - all in Texas. If MBS defaults, it will generate a huge spike up in CMBS delinquencies.

PNC Financial Services Group originated almost all of the loans made to MBS Cos., about 90% of MBS's total loan exposure. Most of those loans are no longer on PNC's books because they were off-loaded into commercial mortgage backed securities (CMBS), which were then sold in the public markets and the risks spread to hundreds, if not thousands, of individual investors.

It's Payback Time

Ability and willingness of banks to do commercial real estate deals is dropping like a rock. As the above disaster shows, banks are going to start worrying (with good reason) about collateral on the deals they have already committed to even if the losses on places like MBS Cos. are spread around.

It's too late now to do anything about it, but there is rampant overcapacity everywhere. Let's face the facts: We do not need more Pizza Huts (YUM), Wal-Marts (WMT), Home Depots (HD), Lowes (LOW), Targets (TGT), Walgreens (WAG), nail salons, or strip malls in general. That overcapacity will soon manifest itself in increasing layoffs and canceled expansion plans. Even stores that want to expand are going to find the cost of funds will rise dramatically.

Those that expect strong job growth are looking in the rear view mirror. With sinking commercial real estate, there is simply no driver for jobs. The BLS can continue to play games with its birth death model (see November Jobs On Bizarro World) but pretending the economy is creating jobs and actual job creation are two different things.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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