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Ann Hermes/The Christian Science Monitor

The John Hancock Tower in Boston has lost more than half its value since 2006, according to an estimate by one real estate adviser.

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Reporter Ron Scherer discusses the financial problems some commercial real estate developers are running into.

Reporter Ron Scherer

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New York

Now it’s the real estate developers who are slated to get a bailout.

By April, the federal government expects to have a plan to refinance office towers and shopping centers in danger of defaulting. The scale is likely to be massive: Last week Federal Reserve Chairman Ben Bernanke hinted at providing another $1 trillion in credit.

The goal, he said, is to head off a “looming crisis” that could spread far beyond “For Rent” signs and shuttered mall shops. For now, commercial delinquencies are few. But office vacancy rates are heading toward record levels, according to one estimate, and banks are exposed, with $1.72 trillion in commercial real estate loans outstanding as of Feb. 18.

Just as significant, many insurance companies and pension funds have invested in real estate, putting them at risk, as well.

“The need is urgent,” says Kenneth Rosen, a professor of real estate at the University of California in Berkeley. “It is important to get this done before we have another problem.”

Due: $300 billion

This year some $300 billion in loans to developers are due to be refinanced by commercial banks. Given the decline in the economy, many real estate ventures might not be able to survive if they are not able to refinance their loans on better terms more reflective of today’s economic conditions. But banks are largely refusing to refinance as the properties drop in value.

Any bailout of real estate developers – some of whom are known for their extravagant living (think Donald Trump) – would essentially be part of the continuing bank rescue. “The banks have significant exposure,” says Mr. Rosen.

To help free up money for commercial real estate, the US Treasury and the Federal Reserve are expected to offer refinancing through a federal program called the Term Asset-backed Loan Facility (TALF) next month. TALF is already providing a backstop for securitized debt such as credit cards and auto loans.

Skyscrapers and pension funds

Yet the concern for the commercial real estate market goes beyond banks to the insurance companies and pension funds who have invested in real estate or made loans to real estate developers.

“Now, to some extent, there is the potential to spread the financial crisis to insurance companies and peoples’ pensions,” says Jon Southard of CBRE Torto Wheaton Research, a real estate research company in Boston.

The impact of the current downturn is already being felt. The market for the packages of loans sold to investors, called Commercial Mortgage Backed Securities, has frozen completely since July. Now, even the highest-rated packages – for those ventures seen as having virtually no risk – are being marked down to produce a 11 to 12 percent interest rate.

The concern is that some large bank will be forced to sell its holdings, overwhelming the market, says Mr. Southard. “The banks are not necessarily in this as a long-term holding,” he adds.

With virtually no new loans available for new commercial buildings, “everything is being postponed,” says Rosen. “There won’t be any new construction in 2010 or 2011.”

Many of the problems for real estate moguls are being caused by the recession. With layoffs, firms are downsizing their office space needs. The national vacancy rate for offices at the end of 2008 was 14 percent, up from the recent low of 12.5 percent in the middle of 2007, Southard estimates.

“But we think it will top 20 percent in 2011,” he says. That would be an all-time high.

Lower rent prices?

As more office towers put out the “For Rent” signs, rents would likely fall. “We expect double-digit declines over the next three years,” Southard adds.

One example of how the market has worsened: Boston’s John Hancock Tower. Broadway Partners bought the iconic blue sliver of glass and steel for $1.3 billion in 2006. Today, based on rent and occupancy expectations for the Boston metro area, it may be worth as little as $575 million to $735 million, says Victor Calanog, director of research at Reis, a real estate advisory company in New York.

“When the building was purchased, that was a good year at the time, and the price was reasonable – if the good years had lasted,” says Mr. Calanog.

In Miami, rents in office towers are now down to 2003 levels, says Tere Blanca, president and CEO of Blanca Commercial Real Estate, Inc. The vacancy rate for office space is about 13 percent.

Empty shop windows at the mall

Problems are cropping up in shopping centers as well. Large regional malls had a 7.1 percent vacancy rate in the fourth quarter of 2008 – the highest level since 2000, according to Reis. “They are in trouble because, for the first time in 17 years, the consumer has scaled back their spending,” says Calanog of Reis.

When a mall operator loses a retail client, the effect may spread to other retailers in the same area.

“Empty stores in a mall deters shoppers just like it deters them in downturn areas if there is vacant space at street level,” says Todd Sinai, an associate professor of real estate at the Wharton School at University of Pennsylvania in Philadelphia. “Then if your retailers stop selling you cannot get new tenants.”

In a few cases, mall operators are delinquent on their loans. The operator of the Promenade at Dos Lagos in Corona, Calif., has missed some payments. But Joshua Poag, president and CEO of Memphis-based Poag & McEwen which runs Corona, says by e-mail that the company is current with its eight other malls.
In fact, the delinquency rate on commercial mortgages is only 1 percent at this point.

“The problem is refinancing,” says Rosen.

Opportunity among rubble

At least one debt-free real estate investor, the Gaedeke Group in Dallas, Texas, views the current situation as an opportunity.

“We are looking to buy assets,” says Belinda Dabliz, vice president of leasing. “There is a lot of debt coming due, and people have no way to restructure it.”

But if the federal bailout doesn’t happen, “we’re going to get a wave of delinquencies,” says Rosen.

Does that mean real estate developers such as Mr. Trump or Mort Zuckerman – both living the lifestyles of the rich and famous – will be looking for help from the government?

“The great hope is that every player in affected markets will somehow survive the coming – or is it here already – storm,” says Calanog. “The difficulty is ensuring that players who behaved poorly – borrowed, lent, or paid too much – are also penalized, otherwise we run into the classic moral hazard problem.”

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