NAR: Weak economy and lack of credit hobble commercial market

WASHINGTON – May 15, 2009 – Access to credit and refinancing issues have seriously affected the commercial real estate markets, but recent Federal Reserve actions may ease the crisis, according to presentations at a commercial real estate forum yesterday at the Realtors® Midyear Legislative Meetings & Trade Expo.

National Association of Realtors (NAR) Chief Economist Lawrence Yun says a commercial downturn is in the early stages.

“Commercial real estate is the hardest hit industry outside of the auto industry,” Yun says. “A recovery in commercial real estate always lags a general economic recovery, but with the right policy prescriptions we can recover more quickly.”

While the commercial and multifamily real estate industry plays a vital role in the economy, it faces its worst liquidity challenge since the Great Depression. Hundreds of billions of dollars in commercial loans are expected to mature this year, and more than $1 trillion will mature over the next few years. Without greater liquidity, commercial borrowers would face a growing challenge to refinance debt. The threat of rising delinquencies and foreclosures could cause widespread damage to the overall economy. Over the past year, commercial investment transactions have essentially ground to a halt.

Commercial loan delinquencies had been stable at about 1 percent, but have risen recently to about 5 percent due to a lack of refinancing activity. “Right now, cash is king,” Yun says. “With so few transactions taking place, a pent-up demand may be building.”

While commercial fundamentals are weakening, they’re still better than in the last downturn in the 1990s, Yun adds. “NAR engaged with the Federal Reserve to buy commercial mortgage-backed securities via Term Asset-Backed Securities Loan Facility (TALF) and Troubled Asset Relief Program (TARP) funds to restore some credit to the market,” Yun says.

In response to the liquidity crisis, the Federal Reserve recently announced that commercial mortgage-backed securities will be eligible collateral under the TALF starting in June. The Fed also authorized up to $100 billion in TALF loans with five-year maturities to help investors finance CMBS purchases. TALF loans currently have maturities of three years.

NAR, which had been advocating extension of the maturity terms, is also asking Congress to enhance federal tax policies that strengthen the commercial real estate market, such as maintaining the capital gains tax rate at 15 percent. “Raising the capital gains tax would (lower) commercial property values, so we’re hopeful they’ll leave it where it is,” Yun says.

For transactions in the current market, Yun says small local banks and savings and loans are a good source of commercial credit. “Many small banks are in good shape and have the capacity to lend.”

NAR’s forecast for four major commercial real estate sectors is being revised and will be released with the Commercial Leading Indicator on May 20.

Robert Davis, executive vice president for mortgage markets and financial management at the American Bankers Association, says the market is in an unusual cycle. “It’s paradoxical – banks did better than expected in the stress tests and most are well capitalized,” he says. “A huge problem for lending from the collapse on Wall Street has been the modeling for risk management. They don’t know how to price risks, and this led to the collapse in liquidity.”

Davis says that confidence must be restored in discerning the market. “When people believe the pricing that comes out of the models, we’ll have an increase in liquidity. As banks stabilize, they’ll be able to offer more balance-sheet lending.”

Banks are restrained by regulators reluctant to allow much new lending. “We need progress in accounting rules. Regulators should look at cash flow rather than credit ratings in determining capital reserve requirements for a particular bank,” Davis says. “Having a steady state of uncertainty is a prelude to recovery. The longer we are in a situation with no surprises, the closer we are to returning to a normal state of lending. We shouldn’t over-trust technology in the lending market – we need to reestablish modern finance with better modeling.”

© 2009 FLORIDA ASSOCIATION OF REALTORS®

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