Tuesday, May 26, 2009

“Curses are like young chicken, they always come home to roost” And So Has the Debt of Commercial Real Estate

So you thought what we’ve seen so far is bad? New research from Deutsche Bank indicates that there is another financial crisis coming, specifically a “refinancing crisis”. It deals with the large amount of high risk, debt fueled loans which were taken out to finance commercial real estate investments between 2005 and 2007. Now with the value of these properties gravely diminished, it is projected that many people will have no choice but to default.
Starting in 2005 and peaking in 2007, underwriting standards went on a perilous “walk on the wild side”; bloating loans with so much leveraged debt that today they resemble cumbersome humpty dumpty’s teetering atop the crumbling walls of our nation’s financial institutions. A key element of debt (recently forgotten) is that at some point it needs to be repaid; in terms of loans this translates to the maturity date, when the principle on the loan is due. For a while people thought that this judgment day could simply be pushed back with the push of a few magic buttons on our financial calculators. But alas, it seems this time people will either have to pay up or get out of town (literally). However, if you fall into this unfortunate category, be comforted, for you certainly do not travel alone.
Of all the loans which are set to mature in 2009 or thereafter, 68.3% ($601.9 billion) do not qualify for refinancing. Coupled with the fact that commercial real estate prices have dropped 40-50% or more, it becomes obvious that most people will have no choice but to default either at maturity or sooner, translating to massive market upheaval.
However, hidden within all this pessimism there is still opportunity. Unlike previous commercial real estate crashes, such as that of the early 1990’s, this crash has little to do with oversupply. So though many people may default and loose their properties, the properties themselves will still have definitive value. It is better to think of this crisis as a cleansing of the system, a removal of all the risk and debt which plagued us. Concurrent with the outflow of bad money will undoubtedly be an inflow of good money and a sound ground for the future.

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