More Shoes To Drop - Commercial Real Estate

By Matt Apuzzo
ASSOCIATED PRESS
WASHINGTON -- Black Friday's retail shoppers hunting for holiday bargains won't be enough to stave off what's likely to become the next economic crisis. Malls from Michigan to Georgia are entering foreclosure, commercial victims of the same events poisoning the housing market.
Hotels in Tucson, Ariz., and Hilton Head, S.C., also are about to default on their mortgages.
That pace is expected to quicken. The number of late payments and defaults will double, if not triple, by the end of next year, according to analysts from Fitch Ratings Ltd., which evaluates companies' credit.
"We're probably in the first inning of the commercial mortgage problem," said Scott Tross, a real-estate lawyer with Herrick Feinstein in New Jersey.
That's bad news for more than just property owners. When businesses go dark, employees lose jobs. Towns lose tax revenue. School budgets and social services feel the pinch.
Companies have survived plenty of downturns, but economists see this one playing out like never before. In the past, when businesses hit rough patches, owners negotiated with banks or refinanced their loans.
But many banks no longer hold the loans they made. Over the past decade, banks have increasingly bundled mortgages and sold them to investors. Pension funds, insurance companies, and hedge funds bought the seemingly safe securities and are now bracing for losses that could ripple through the financial system.
"It's a toxic drug and nobody knows how bad it's going to be," said Paul Miller, an analyst with Friedman, Billings, Ramsey, who was among the first to sound alarm bells in the residential market.
Unlike homeowners, businesses don't pay their loans over 30 years. Commercial mortgages are usually written for five, seven or 10 years with big payments due at the end. About $20 billion will be due next year, covering everything from office and condo complexes to hotels and malls.
The retail outlook is particularly bad. Circuit City and Linens 'n Things have sought bankruptcy protection. Home Depot, Sears, Ann Taylor and Foot Locker are closing stores.
Those retailers typically were paying rent that was expected to cover mortgage payments. When those $20 billion in mortgages come due next year, many property owners won't have the money.
Refinancing formerly was an option, but many properties are worth less than when they were purchased. And because investors no longer want to buy commercial mortgages, banks are reluctant to write new loans to refinance those facing foreclosure.
California, New York, Texas and Florida -- states with a high concentration of mortgages in the securities market, according to Fitch -- are particularly vulnerable. Texas and Florida are already seeing increased delinquencies and defaults, as are Michigan, Tennessee and Georgia.
The worst-case scenario goes something like this: With banks unwilling to refinance, a shopping center goes into foreclosure. Nobody can buy the mall because banks won't write mortgages as long as investors won't purchase them.
"Credit markets have seized up," corporate securities lawyer Michael Gambro said. "People are not willing to take risks. They're not buying anything."
That drives down investments already on the books. Insurance company's stock prices are falling on fears that they have invested in too many commercial mortgages.
"The system has never been tested for a deep recession," said Ken Rosen, a real-estate hedge-fund manager and University of California at Berkeley professor of real-estate economics.
One hope was that the U.S. would use some of the $700 billion financial bailout to buy shaky investments from banks and insurance companies. That was the original plan. But Treasury Secretary Henry Paulson has issued a stunning turnabout, saying the U.S. no longer planned to buy troubled securities. For those watching the wave of commercial defaults about to crest, the announcement was poorly received.
"He's created havoc in the marketplace by changing the rules," Rosen said. "It was the stupidest statement on Earth."