Thursday, September 10, 2009 It’s the Loans, Not the Land: The CMBS Refinancing Crisis

It seems to be a generally accepted fact that Commercial Real Estate is about to hit the ground like a ripe watermelon thrown off a ten story building. Stories abound about how its impending collapse will send systemic shocks rattling through our weakened economy, delivering a rude kick to the face just as it is trying to get up. Investors stand quivering on the sidelines and banks are trying to find out how they can hire Jimmy Stewart (aka It’s a Wonderful Life) to perform some crowd control once their money evaporates with the popping of this last bubble. And you know what? These predictions, dire as they are, may not be totally off base. If recent reports are to be believed, things are not all well with the world. The delinquency rate for CMBS rose to 3.14% in July, which is more than six times as high as the level last year and by 2012, $100 billion of the $153 billion worth of CMBS loans (65%) will face difficulties being refinanced. With this kind of information, it’s easy to see why so many are pessimistic. The thing to be remembered, however, is that this is all the result of massive artificial inflation. There is nothing inherently wrong with the land; there is nothing inherently wrong with commercial real estate. There was something horribly wrong with the way people behaved between 2004 and 2007. Essentially, taking a Louisville Slugger to the figurative credit piñata and declaring “come get it!” resulting in drastic overpricing and horrible loans. The land itself was the innocent victim of this all and today faces the repercussions of our malfeasance. In-fact, the cash flow from most of those properties whose loans expire in 2012 is enough to “pay interest and principal on their debt”. Even in the midst of this deep recession, commercial real estate is still producing wealth. The problem is that its values have inevitably fallen from their inflated

highs, making it almost impossible for borrowers to extend their existing mortgages or refinance with more debt. But is this necessarily a bad thing? Clearly the market was flooded with bad credit, so is it wise to take out more debt, or in the case of government action, tax payer funded debt, to refinance bad loans? Perhaps it is best just to let the market clear itself of its toxic waste. We collectively went on a binge of epic proportions and today have to face the consequences. But we never destroyed or devalued assets, we overvalued them. When the dust settles it will be found that commercial real estate is still a great investment, still capable of building wealth and in reality, still is today. If the economy does get hit by a wave of CMBS foreclosures, it’s not because of the land, it’s because of us.

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