BLOG VIEW: When Is A Frozen Pipe A Crisis?

At some point in the very earliest hours of 2009, a water pipe in my apartment decided to take after the credit markets and freeze – paralyzing the entire system.

Mutually wary of the catastrophic property damage that a burst pipe could create, my landlord and I thus held an impromptu day-long New Year's Day celebration consisting of running back and forth between stuffing a humming hair-dryer in a kitchen-wall crevice and twisting the sink faucets upstairs. Eventually, we coaxed the icy pipe into delivering flowing water through the apartment once again.

Based on this cautionary tale, here's the critical question for our industry: Does the commercial real estate finance market require a similar emergency thawing effort to prevent impending massive wreckage?

A month ago, when we last analyzed the ominous signs appearing in the CRE sector (see ‘BLOG VIEW: Checking On The Other Shoe’), delinquency data and property-fundamentals metrics seemed to indicate that a dire situation was not necessarily imminent.

In other words, the furnace was probably out, but the wintry windchill had not yet kicked in.

Now, all eyes are on the pipe-bursting potential of the enormous sum of commercial mortgage debt that must somehow be refinanced in the next few years. Like the dangerously expanding ice that has no place to expand inside a metal pipe, these loans have essentially no place to be refinanced inside unresponsive financial markets.

Rising vacancy figures and declining property cashflows in most sectors certainly will not help matters. Neither will the recent parade of year-opening headlines (accurate or not) portending a ghastly 2009 for commercial real estate.

Consequently, industry associations and executives, who have sent a letter to Treasury Secretary Henry Paulson urging intervention, now foresee an increasingly probable – and increasingly wide-reaching – crisis.

‘In the midst of historically moderate vacancy rates, low loan delinquency rates and an abundance of well-performing, cash-flowing properties, credit available to commercial real estate is now in exceedingly short supply,’ the groups wrote. ‘For many borrowers, it is simply not available.’

With the sizeable wave of foreclosures predicted to occur as a result, the ruin would likely spread beyond commercial real estate.

‘The stress on the financial system itself would be quite acute, and the impact on local communities and jobs could be quite serious,’ Jeffrey DeBoer, chief executive of the Real Estate Roundtable, recently told the Dallas Morning News. According to the article, CRE employs about 9 million people, and property tax revenues help to sustain local public services.

Who else would suffer in a CREF plumbing disaster? In addition to the major banks, pension funds and others with a stake in CMBS, regional banks – which, as a group, have nearly doubled their CRE lending over the past six years – rank as some of the less obvious predicted victims, the New York Times reports. The article also cites a report from Real Capital Analytics that found that $107 billion worth of office, retail and hospitality loans have become distressed already.

According to the Mortgage Bankers Association, the National Association of Real Estate Investment Trusts and the other authors of the warning letter to Paulson, thawing efforts for commercial mortgage lending must begin immediately.

‘Without leadership by the government through significant policy action, we believe jobs will be further threatened, the banking system will face additional pressures and the savings of countless citizens will be unnecessarily lost or severely eroded,’ the groups note.

Their prescribed course of action includes opening the Term Asset-Backed Securities Loan Facility (TALF) to highly rated CMBS in order to allow credit extension and aid in refinancing performing mortgages and selling CMBS. ‘A variation of this approach should also be adopted to provide liquidity to unsecured commercial real estate loans through the investment-grade corporate bond market,’ the letter adds.

Paulson and his colleagues have yet to issue a decision on whether this plan will be approved. But would these measures even melt the market's glacial contents? Should the Treasury prepare for the worst and grab its TALF blowtorch? Or should we all just turn up the thermostat and hope for the best?

– Jessica Lillian, Commercial Mortgage Insight


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