Major problems with commercial real estate, that is...

In a recent report, the credit rating agency, Fitch Ratings, said that 30% of commercial mortgage-backed securities loans set to mature in 2011 do not pass their refinance test. Another credit rating agency, Moody's Investors Service, said recently that although the commercial real estate markets are making their way toward recovery, most still have not reached a point of stability.

Uh huh.  "Extend and pretend" has been the rule of the game thus far.  That is, pretend a loan is performing and meets covenants even if it doesn't, and extend maturities instead of forcing an actual roll, when the default would come out into the daylight like a vampire forced into the sun, immolating itself into ash.

Drive around.  The "For Lease" signs are still sprouting. And when it comes to commercial real estate there is a decade's worth - or more - of oversupply.

Commercial Real Estate loans have almost-always been written not on a fully-amortizing basis with an intent to eventually be debt-free, but rather on a cash-flow-positive basis.  That is, the economic activity in the shopping center or whatever it is supports the interest payments on the note, and the principal is rolled over when the term expires.  Extending that scheme into the residential real estate marketplace with OptionARM and other similar loans is a big part of what detonated the residential market, because residences are not revenue-producing things, and thus should never be financed in that sort of fashion.

The bankers didn't care about that, of course.  All they cared about was being able to skim off a piece of every transaction, and that's exactly what they did - right up until it blew up in their face.  Like the sellers of picks and shovels during the Gold Rush, the presence or absence of actual gold didn't bother them one way or the other - only the hype mattered.

Unfortunately the same meme infested commercial real estate.  "If you build it they will come" was the mantra.  This, of course, is fantasy - if you build it the people with the disposable income have to be there and spread that income around your merchants, or they don't come and you go broke.

The options for working these loans out are limited.  If the property is in negative equity, and many of them are, either having been refinanced with "light" covenants or built during the bubble years, reasonable qualifications are not going to be able to be met.  Lease stability is always in question in a commercial situation, as it only takes one anchor tenant to blow up to ruin the property's coverage ratio.  Once you get in trouble on ratios you're cooked as there are few ways out of the trap.

MCSNet was able to take advantage of one of these circumstances in the 1990s for our office space.  But that was during a mild and shallow recession where a building owner had allowed tenants to get a bit far out on the tightrope without a safety line.  This is a common thing to do during booms, as there's competition from new buildings and renovations that make it very difficult to stick with your standards and remain safe.

Those who think that these loans aren't the rough equivalent of an overpressurized dive tank that someone is whacking on with a sledge are delusional.  They are, and that which cannot go on forever in the form of "look the other way" forbearance won't.

We're about out of time on this little charade, and the economic "uptick" everyone was counting on to rescue the lenders has simply not materialized.

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