So far the big news in real estate remains the depression-esque performance of the housing market. And with good reason, since the plunge in housing prices and surge in foreclosures has precipitated much of the economic mess we are now in. However, the commercial side of the real estate market is emerging as another area of concern. To date, most of the pain has been felt on the transaction and financing side of commercial real estate deals as data show industrial, office and lodging construction activity hasn't weakened very much. Unfortunately, in an environment where payrolls, consumer spending, industrial output and business travel are all declining, new construction is only pushing property vacancy rates higher.
Vacant properties do not generate much rent growth and can cause building owners to default unless they can refinance or receive payment extensions-a dicey situation with a credit crisis in full swing and property values falling. Many regional and community banks provided the lending for these projects, leaving them on the hook if loans didn't perform. The dollar trail doesn't end there, however, since many loans were structured as commercial mortgage-backed securities (CMBS) and sold to larger banks and insurers. Declining values of underlying asset could spark a cycle of CMBS ratings reviews, credit downgrades, and bank capital losses similar to what happened last fall when the market for residential MBS imploded. The volume of commercial lending is smaller and default rates would have to soar before the situation would look anywhere near that bad; nonetheless, the commercial property market downturn is only beginning and will likely claim its share of victims too, even if policymakers use the bazooka in their back pockets.