'Double Bubble' Means More Real Estate Trouble ["Developers Face Huge Crunch"]

'Double Bubble' Means More Real Estate Trouble Developers face huge crunch as downturn hits office buildings, malls, hotels

Owners of commercial properties — especially those that aren't generating cash — face a major squeeze when their loans come due in the next few years. Prices are down 35 percent from the peak, making it all but impossible to refinance some commercial properties.

By John W. Schoen Oct . 22, 2009 That big whoosh you're hearing is the air rushing out of a commercial real estate bubble.

More than two years into the worst housing crisis in decades, commercial real estate is shaping up as the second half of what some are calling a “double bubble.” Owners of shopping malls, hotels, office space and apartment buildings — and the bankers who financed them — face a major crunch over the next two years as the mortgages on those properties start coming due.

Much like homeowners who now owe more on their mortgage than their house is worth, many commercial property owners have seen the value of their properties plummet, increasing the risk of default on hundreds of billions in commercial real estate loans.

Below is from a thread back on 9/15 that discussed this upcoming problem. A poster had asked something to the effect about why this is coming and why it is taking longer to get here.

Here is a simplified way to explain how commercial realestate works. You are the “Owner” (managing partner of a group of un-named investors acting on behalf of them all with their consent on most financial decisions). For this example, we assume you represent the group.

The economy is good (old lending standards) and you find a good piece of land that will fit nicely in a business model at the right price. You pool money to the tune of 5% and expect a 20% return. You develop your property using the funds loaned to you with only 5% of your own money. You get the building leased up and are planning to make 20% on your 5% over 10 years. Your lease rates ensure that. This includes your 20 year mortgage payments and all expenses from taxes, utilities, insurance, renovations, etc. You are booking and taking profits at a steady pace 5 years into it. The economy tanks, several tenants default your revenue drops below first projected revenue then after two years below real revenue. You have made some good money in the first 5 years and want to hold out expecting that return to come back. You may only be making 18% after 20 years now, but you can hack it. To slow the bleeding, you offer lower lease rates for the vacancies. As tenants renew leases or learn of it, they all want to negotiate their terms. Now you are operating at a monthly loss. But you made money and there is still money in the bank to cover the losses.

At some point your actual losses forecasted completely eat away all your profits and you are coming out of pocket. A sale of the property would not pay off the mortgage and you are stuck. You and your partners decide to file bankruptcy and dissolve the LLC with some winnings still in tact.

Again, these are deals made in the old economy that was so horrible under Bush. We are just about getting to the point where investors are looking at their losses and deciding to bag up what they have left and giving it to the lender.

From a thread on 9/15 explaining the coming commercial realestate crunch:

http://www.freerepublic.com/focus/f-chat/2340309/posts

Very good post -- and excellent case study you presented there.

That also explains why a commercial property I own is still doing OK, even as an identical property next door is getting hammered. Lease rates are down at least 35% across the board . . . which affects both properties equally. But the one I manage was purchased by my family 25 years ago for less than half the unit price ($/sq.ft.) than the price on the building next door that was purchased by the current owner two years ago.

At lease rates 35% lower than they were 18 months ago, the owner next door is facing a disaster. We, on the other hand, can take it in stride because even at lower lease revenue we were able to refinance the mortgage a few months ago for another five years -- and at historically low interest rates.

Commercial Realestate will lead the second half of this recession, from what I know. The commercial investors have been eating their own equity in the form of interest payments while land goes unsold, development is stifled by manufacturing, distribution, warehouse and office vacancies fall or stagnate. There will come a time when the big money runs out and losses will be booked and unloaded. Commercial property values are way down and default in many cases will be a better option than a fire sale. Also, most development is financed by LLC investors that are protected. When they run out of money and the proceeds from a sale will not cover a loan, they will liquidate, fold and walk. The old money out there with staggering lien leveraged assets will see lenders in a second wave of crisis. The unit numbers will not be so high but the dollars will be staggering.

Why haven't we heard more about this? It is bad business for an investor or a proprietor to announce that he is having trouble with investments or that he can't pay his bills. It is the investors that are credited with securing financing from lenders and much of it comes with secured down payments and the credit worthiness of the application participants. They do not want to announce, "Hey, we are just going to give that one to the bank." then turn around and ask, "Look we have all this money. Can we get a loan to purchase and develop this property?" They do all they can to hid their identities as it is for this very reason.

Here is the response I initially posted that asked for an explanation. I suppose it would make more sense if the question had some reference. Again, this was my position over a month ago.

I cannot get the link to the original article to work.

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