Commercial Real Estate Frontline

In this credit crisis we haven’t seen widespread commercial real estate foreclosures and default…so far. But that doesn’t mean the sector is impervious to distress.

The Wall Street Journal reported:

One sliver of the commercial-lending market — securitized mortgages — carries a delinquency rate of 0.54% representing $4.6 billion, according to credit-rating firm Realpoint LLC. Some analysts expect that rate to as much as double within the next year. The current delinquency rate is deceiving, though. The largest volume of commercial lending with loose standards occurred from 2005 to 2007. So, a big foreclosure surge awaits when those loans come due between 2010 and 2012, said Mike Kirby, director of research at Green Street Advisors.

If you’ve been in the business for any length of time you know this to be true. From 2005 through 2007 the volume of deals and the amount of leverage in the deals both soared. As prices continue to correct and as the notes written during that time begin to roll I think its likely that we are going to see some more than just failed developments and sub-prime residential loans in default.

What to do about it.

If you’re a buyer you must buy based on cash flow today. Also, don’t expect to get debt at better than a 65% LTV and at 1.25 on the debt service. If you are buying something with significant vacancy the property should be priced accordingly. Vacancy rates are not expected to improve in the short term unless you’re buying multifamily.

If you’re a private seller fill your vacancies. Do what you have to to keep your existing tenants. If you have leases expiring in the next 12 months have a representative start talking with your tenants now or do it yourself, but get them into a new contract. Lastly, remember a buyer’s ability to put debt on your property is contingent upon your ability to document your income and expenses. Keep your records tight.

If you’re a lender and you have those loans that you just know are marginal (the ones that you’re thinking about late at night) open the lines of communication. Most borrowers don’t want their lender to know that they see trouble down the road, they’re not likely to call you until they’re in real trouble. Make a preemptive strike and refer your investment experts to the borrower; there are lots of creative ways to add income, reduce expenses, and increase cash flow. These moves can help the borrower to weather the storm. If it turns out that the loan ends up in workout in the end at the very least you’ll have a salable asset and not an albatross that will sit on your books.

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