Forex

The commercial real estate market has in most cases held up better than the consumer side, but it is possible that the situation is about to worsen for the business side of the ledger.

One commercial real estate fellow with a fair amount of experience in the Texas market told us last Friday that his business was in fairly good shape, due to the fact that he had been very careful in vetting his locations, clients and partners.

Yet, this very level headed fellow also told us that there were definitely some areas in Texas that were already showing signs of weakness, especially the areas where high growth of residential housing in the Dallas-Ft. Worth Metroplex had been evident, such as Frisco and Plano.

Still, not everyone is as sanguine as our real estate mogul. According to The Wall Street Journal "After suffering a beating from their exposure to home loans, banks and securities firms are about to take their lumps from office towers, hotels and other commercial real estate. And the losses could last longer than those from the subprime shakeout."

Noting that "commercial-real-estate values are starting to slide," the Journal reported that Goldman Sachs is "projecting a decline of 21% to 26% in the next two years. That means misery for securities firms with exposure to commercial-real-estate loans and commercial- mortgage-backed securities."

In other words, at least one Wall Street firm, the one that made money shorting subprime loans, is now expecting a significant decline in commercial real estate, one of the final underpinnings of the U.S. economy.

So why is Wall Street suddenly worried about commercial real estate loans? One simple reason is that there are far fewer commercial real estate loans that have been securitized. According to the Journal, only some 20-some percent of commercial real estate loans have been packaged into some kind of security, as opposed to the 80% of mortgages.

That means that there are far more loans of uncertain value out there in commercial real estate. And that means that it will take longer to value them, write them down, and be done with the issues that may present.

In fact, according to the Journal: "Wall Street has set itself up for a hard fall in commercial real estate. Banks and securities firms are facing exposure from loans and financing commitments made on commercial-real-estate projects, property they own directly and commercial-mortgage-backed securities that no one wants to buy."

According to what Goldman Sachs told the Journal, investors should expect some "$7.2 billion" in commercial real estate writedowns "by Bear Stearns Cos., Citigroup Inc., J.P. Morgan Chase & Co., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Morgan Stanley in the first quarter," as "those firms had combined commercial-real-estate exposure of $141 billion at the end of the fourth quarter."

And it's possible that although the decline could last longer than that in housing, it may not be as bad, since "excesses that overtook the U.S. housing market aren't as prevalent in commercial real estate. Overbuilding of shopping malls, office parks and other commercial property hasn't been rampant, although vacancy rates are climbing in such markets as Orange County, Calif., and Las Vegas, which have been hit by the weak housing market."

Still, if the economy turns down fast and far enough, it is possible that things could be worse than Goldman analysts expect.

And there is a lot of uncertainty. "So far, default rates on commercial-mortgage-backed securities are a slim 0.4%. But that is likely to rise as loose lending standards on some commercial-real-estate loans come back to haunt lenders and investors. More than $50 billion of five-year, full-term interest-only loans written at aggressive loan-to-value ratios could turn into defaults "at a significant level" if the loans can't be refinanced this year, according to Jones Lang LaSalle, a real-estate brokerage and money-management firm in Chicago."

Conclusion

Last Friday we wrote that "we may be seeing the start of the true unraveling of the housing boom, the accelerated, "blood in the streets" period that finally cleanses the market and sets up the next stage, either a base, or some kind of rally."

Now, it's possible that the economy is in enough trouble to be causing a stall in the commercial real estate market, a very steady performer during the recent difficult times.

The real question seems to be not if, but when it will happen, and how deep the hole will be for commercial real estate.

In our opinion, it's unpredictable, and a whole lot depends on those factors passed onto us by the fellow we curbsided last week.

Thus, it is possible that in contrast to housing, commercial real estate's problems may be more regional in nature and selective in their damage.

Above all, though, it seems as if the fate of the sector may be more dependent on the overall state of the economy. And that's where any kind of analysis and future projections fall into the realm of the very risky.