Monday, August 10, 2009

Commercial Real Estate is Collapsing: Will The Fed Bail It Out?

As our economy braces for round two of the residential real estate collapse (see earlier posts for data), the commercial real estate market is in full blown collapse. Formerly high-flying Maguire Properties is the latest REIT to hit the wall, as it just announced that it is turning seven buildings with over $1 billion in debt over to its creditors:

I Would Bet Maguire Is Completely Insolvent

As businesses close down, they are no longer able to pay their leases and tenants that remain are negotiating greatly reduced lease terms. The problem is, just like with the housing bubble, commercial real estate became catastrophically overbuilt and overvalued. As the underlying economics collapse (i.e. tenant cash flow) so too does the value of the properties. You can see what's happening with vacancy rates in the biggest cities from this graph from an article in today's Wall Street Journal:

It will be interesting to see if the Fed addresses this situation when they release their policy statement from this week's FOMC meeting Wednesday afternoon. We already know that Bernanke has included Commercial Mortgage Backed Securities as part of his buy-worthless-assets-with-taxpayer-money program. But will the Fed become even more proactive in attempting to support the unsupportable other than with printed money?

The commercial real estate mortgage market is over $3 trillion (this included multifamily apartment buildings). What makes this catastrophe worse is that we have no idea of the total size of the derivatives which are attached to this debt. There is just no possible way that lending "stress tests" incorporated the above vacancy rates when most of the current commercial mortgage paper was underwritten.

The banks are soon going to facing the second wave of residential housing defaults AND a tsunami in commercial real estate defaults. Rest assured the the stock market and the U.S. dollar will not fare well in this next storm. We suggest moving a healthy portion into the only port with a 5000 year track record of survival - gold.


  1. In answer to your question, yes the FED will backstop CRE, what else can they do? I think you are so right about the magnitude of this coming bailout, perhaps this is why the bond sales are doing poorly? Add to this, people were pretty mad about bailing out mortgage hilders, but at least that is a person; nobody is going to want to bailout huge REIT and other holders of this stuff.

    On a metal note, I was going to write about this catch tonight, but China is offerring silver bullion to the public now for personal investment:

    We are in trouble if this sort of thing catches on. Great site by the way.

  2. thanks for the feedback GYC. I saw that China/silver thing yesterday morning and thought about doing a blog post about it.

    Interestingly, starting with gold about 18 mos-2 yrs ago, the Chinese Government has put in programs to encourage the population to accumulate gold and now silver. It fits in with my theory on how China plans on clawing back the wealth it loses when the dollar collases...

  3. Of course the FED will hold CRE. It will be very interesting how they are going to explain that bailout!

    The Journal also reported that JP Morgan is putting up 23 properties. One of which is this behemoth in NYC. One Chase Manhattan plaza, which is right across the street from the NY FED.