As we have said on many occassions, commercial real estate is a lagging economic indicator. We have seen the strain in other areas like residential property (sub-prime crisis), rising food and gas prices, and a tightening of consumer finance options (Home Equity Lines Of Credit (HELOC), Credit Card Defaults, etc.).

Now the tail is finally starting to wag the dog (as we indicated in our recent Blog post — What the Fed Did NOT Say : US commercial real estate prices have registered their largest monthly decline since the inception of the Moody’s/REAL Index.

Moody’s said the Index stood at 174.97 in May 2008, down 3.5% from the previous month, and 5.7% below the same period last year. This represents three consecutive months of negative returns, and the largest one-month drop since the inception of the index.

Nonetheless, the CPPI still logs an increase of 3.9% over a two-year time period.The index now stands 8.8% below the peak in October 2007. Moody’s also noted that the average transaction price is steadily falling as transaction activity continues to shift to lower priced assets.

According to Noah Rosenblatts post in UrbanDigs,

we are currently in a CRECESSION. 

Noah coins an interesting term that describes the odd economic state that we currently find ourselves in. He calls this state a – Crecession. Here is the formal definition: 

A period of economic activity where available credit is contracting and the cost of credit is rising, leading to a disruption in the credit markets and difficulties for businesses that borrow short and lend long. The result will likely be a period of asset deflation leading to a lack of growth, rising unemployment, and rising commodity inflation due to pressure on the dollar. 

Seems right on the money to me …… 

So, will you survive the CRECESSION?

Here’s the potential $2.8 trillion dollar question. In a revealing article in the New York Times, they investigate the question of how bad could things get? Since World War II, there have been 18 banking crises in industrial countries. The worst five were caused by changing lending standards or real estate bubbles (often both) and cost at least 6 to 20 percent of G.D.P.; the U.S. equivalent of $850 billion to $2.8 trillion.

These are the worst five in history:

Spain, 1977,

Norway, 1987,

Finland, 1991,

Sweden, 1991 and

Japan, 1992. Click here to see the hard data and the charts.

But Can Past Banking Crises Tell Us Anything About What’s Next?

In a startling revelation, in the four years leading up to the current crisis, home prices behaved much as they did in the worst crises of the past, according to a study by economists at the Univerity of Maryland and Harvard, entitled: Is the 2007 U.S. Sub-Prime Financial Crisis So Different?

If the trend holds, prices will fall an additional 15 percent in the next three years.But, how does the current downturn compare with past U.S. recessions?

There are signs, but no one knows what the future holds for sure. What we can say is that we continue to track current events and are zealous about analyzing history to see if there are any tell-tale signs to guide our readers and clients moving forward.  These reports many not be fully dispositive, but they are instructive, nonetheless. History often comes close to repeating itself. Will this time be different?

The Wall Street Journals Jonathan Karp provides a fascinating expose’, entitled HARD MONEY: Real-Estate Financier’s Death Hints At Trouble for Lenders, detailing a griping personal tale of Scott Coles and his company Mortgages, Ltd., that outlines a bizarre set of facts even greater than what fiction could believably spin.  

Unfortunately this story is true, and arguably representative of not only the past and present realities of the market, but telling of what the future of commercial real estate finance holds for us, moving forward in the days ahead. This is much more than one mans rise and fall …

The Financial Facts: So far, the commercial-property market has been spared the devastating losses felt in the housing market because there wasn’t flagrant overbuilding. Over the past several months, this Blog has documented this phenomena, extensively.

But declining property values and a weakening U.S. economy are starting to bite: Mortgages Ltd. of Phoenix, Arizona and other lenders are reporting a significant jump in loan defaults. That’s placing enormous new pressure on the lenders, which have bet billions of dollars on new construction of commercial properties. Here’s what happens when those bets, fail …

The Real Life Tragic Result: Flamboyant real-estate financier Scott Coles penned a farewell letter, put on a tuxedo and climbed into bed, where he was later found dead in what police believe was a suicide.  

The tragedy last month involving Scott Coles is drawing attention to the condition of the nation’s commercial real-estate market, which is beginning to show mounting signs of distress.

We never sugar coat the news, but rather provide the latest installments of information, unfettered, and in a timely fashion.

Our mission is to evaluate events and provide our clients and strategic partners with critical information that will immediately become valuable assets in their business and personal lives. Todays entry is no exception ….

Chairman Ben S. Bernanke testified before the U.S. Senate today (July 15, 2008) in the Fed’s Semiannual Monetary Policy Report to Congress.

The Howe Street correctly points out that what was UNSAID in the Fed Chairmans statements is as important, if not more so, than what was said.

So what did he opt to omit ?  Bernanke did not mention a thing about the impending commercial real estate downturn.

Here are the facts: As we all know, the expansion of commercial real estate was the last economic driver for jobs. Every major corporation that drove the market — Wal-Mart, Target, Home Depot, Lowes, Starbuck, Pizza Hut — and many more are cutting back, and in a significant way. Accordingly, the Shopping Center Economic Model Is History.

There is a rising glut of vacancies and downward pressure on rents. We know this to be true. Additionally, we know that many regional banks that escaped the housing debacle, undertook commercial real estate bets, instead. Commercial real estate is just one reason why Bank Earnings Won’t Recover. Indeed, as we are now seeing, there are Many Hurricanes, Many Eyes. Many experts believe that Bernanke still maintains a myopic eye, which is focused on the last hurricane (sub-prime lending), and based on his public comments today, he appears is unable or unwilling to see the other significant storms that are soon approaching, right over the horizon.

Now we all have the news. It may not be great, but we can nonetheless plan accordingly.

As just reported in InmanNews, shares of Fannie Mae and Freddie Mac hit 17-year lows today (July 10, 2008) as investors’ fears about the companies’ ability to raise additional capital fueled speculation of the possibility of a government bailout.

Along these lines, the Office of Federal Housing Enterprise Oversight (OFHEO) has issued a statement on the stability and solvency of the GSEs in response to the unprecedented run on their stock prices as increasing turmoil in the housing losses skyward market drives loans. And just a day later ….. headlines read: Feds Eye Takeover of Freddie, Fannie.

So in spite of government officials efforts to the contrary, reports in both the Wall Street Journal and Bloomberg have renewed talk of government intervention.

Are they really already insolvent? Former St. Louis Federal Reserve President William Poole told Bloomberg Wednesday that because the value of their assets is falling, Fannie and Freddie are already insolvent. In Pooles opinion, a longtime critic of Fannie Mae and Freddie Mac, he beleives that Congress should recognize that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer.

NOTE >> Fannie and Freddie own or guarantee about $5.2 trillion in mortgages, nearly half of the $12 trillion in outstanding U.S. home loans, and have raised about $20 billion to offset $11 billion in losses since the credit crunch hit last year, Bloomberg reported.

In a front page story today, the Wall Street Journal reported that while the government does not expect Fannie and Freddie to fail and no rescue plan is imminent, Treasury Department officials are talking about what the government could — or should — do if Fannie and Freddie become so pressed that they are unable to borrow money and continue operating.

So stay tuned to this saga regarding the fate of Fannie Mae and Freddie Mac.  

What will 2009 do to our home values and networth? Read on, and see what some experts predict.

 BofA sees additional 15% drop in real estate prices: Bank of America expects home prices will fall an additional 15 percent nationwide and 20 percent in California, BofA Chief Executive Officer Ken Lewis said in an interview with the Los Angeles Times.

Bank of America has previously said it plans to lay off 7,500 employees as part of the merger with Countrywide, and engage in workouts or loan modifications with 265,000 borrowers (see story)

Policy center reports home-price impacts on wealth: The Center for Economic and Policy Research, a nonpartisan think tank, reports that if home prices hold steady through 2009 the median household headed by those 45-54 next year will have 24.7 percent less wealth than the median household group in this age range five years earlier. That’s according to a study by the group, The impact of the Housing Crash on Family Wealth.

• The study also found that if real house prices drop 10 percent, the median household headed by those 45-54 will experience a 34.6 percent loss in wealth compared with the median for this group in 2004,

• While households in the 18-34 range will lose 67.6 percent.

• If prices fall 20 percent, families in the 55-64 segment will experience a wealth loss of 49.6 percent compared to the same segment in 2004.

Here we go again. Recently, the headlines have been dominated by the global banks, like Bear Sterns, and their massive missteps and huge losses.

For instance, this just in from CitiGroup: $8.9 billion of write-downs in the second quarter, nearly $15 billion of losses in the last two quarters of 2008, and more than $46 billion of credit losses and write-downs since the middle of 2007.

The troubles, apparently, go far beyond the mega players. Small banks and construction loans: Yet another area within the banking industry that appears to be headed for bad times. So, how will all of this translate to the Maryland Real Estate community?

As reported in the Wall Street Journal today, regulators are increasingly worried about a lending practice that allows real-estate developers to delay paying construction-loan interest but can mask problems at the banks that made the loans.

Small banks, which are more exposed relative to bigger banks, have $280 billion of outstanding construction loans overall, mostly to condominium developers and home builders.

When the loans were made, the banks calculated the interest that would be paid and put that money aside in “interest reserves.” In essence, the banks pay themselves until the loan becomes due or the property generates cash flow.

Regulators fear this practice can be abused to keep recording loans as performing even though the underlying real-estate projects are failing.

The biggest worry about interest reserves mainly has involved small banks because of their heavy concentration in construction lending. These loans normally ranged from $1 million to $10 million to home builders, land investors and developers of commercial properties such as shopping malls and office buildings.

At the end of the first quarter, the $280 billion that small banks had outstanding in construction loans represented about 45% of all such loans, according to Foresight Analytics.

John Caulfield in BuilderOnline, attempts to predict the trending in the Non-Residential market (and read the tea leaves), as it is suggested that the economic downturn seems to be taking its toll on the non-residential sector, which despite a strong year in 2007 and gains as recently as last month, could be faltering a bit. 

Last week, McGraw-Hill Construction estimated that non-residential building during the five months ended in May 2008 had increased 13 percent to $102.3 billion, based on its assessment of projects that were started during that period. However, all that glitters is not gold. Drilling down a bit with respect to these numbers reveals some reasons for concern about this sector’s health.

• Falling Size: The projects being started are smaller: Square footage for non-residential building was off by 9 percent in May 2008 and by 23 percent for 90 days ended that month.

•  Decreased Square footage: Commercial construction (e.g., retail stores) square footage was off 39 percent and office building was down 34 percent.

•  Increasing Cost: The cost per square foot for non-residential building had “skyrocketed” by 34 percent over the previous six months. The housing analyst judges new-order trends as “disappointing.”

One of the more reliable barometers of future non-residential activity—the Architecture Billings Index, which the American Institute of Architects (AIA) calculates—stood at 43.4 in May 2008. That’s better than the 39.7 index in March 2008, but is below the threshold of 50 that indicates a decline in billings.

Some Good News: There appears to be strength in some areas such as public infrastructure, schools, healthcare, and institutional construction. The money for many of these projects had been appropriated years ago, before the downturn in the general economy became apparent. Following a 17 percent increase in 2007, non-residential building is projected to grow in 2008 by a modest 1.8 percent to $465.7 billion, which is expected to level off over the following two years, and then increase again by 7 percent each year in 2011 and 2012 to $536.1 billion.

• Biggest Projected Gains: In 2008, the biggest percentage gains in non-residential construction will most likely come from public safety and transportation (8 percent up each), Other “bright spots,” might be found in construction related to homeland security and prisons, as the inmate population in the U.S. is expanding at a faster rate than the population in general.

• Biggest Projected Falloff: The biggest falloffs in the construction of religious buildings (10 percent off).

As reported by Inman News, the current housing slump is far from over and is shaping up to be the worst in 50 years, according to an annual report on the state of the nation’s housing markets from the Joint Center for Housing Studies of Harvard University.

• Drastic production cuts and deep price discounts in 2005-2007 helped shrink the inventory of unsold new homes from a mid-2006 peak of more than 570,000 to less than 500,000 in early 2008.

• But the number of homes entering foreclosure nearly doubled to 1.3 million last year,

• Vacant homes for sale rose 46 percent over two years, to 2.12 million.

Single-family home prices in the first quarter of 2008 were down 12 percent from their October 2005 peak — 18 percent in real terms, after adjusting for inflation.

Some good news: The report, “The State of the Nation’s Housing 2008,” is more optimistic about medium- to long-term prospects, estimating that unless there’s a serious, prolonged economic decline or a marked cutback in immigration, the nation will gain 14.4 million new households between 2010 and 2020, compared with 12.6 million between 1995 and 2005.

But, how bad is the downturn, really?

• The report noted that sales of existing homes fell 13 percent in 2007 to 4.9 million, and sales of new homes were down 26 percent to 776,000, the lowest level since 1996.

• The 500,000 unsold new single-family homes available in early 2008 was down from a mid-2006 peak of more than 570,000, but the slower rate of sales translates into an 11 month supply – a number not seen since the 1970s. A supply of more than six months is considered a buyer’s market, and the inventory of existing single-family homes rose to 10.7 months in April.

• Housing permits fell 24 percent nationwide in 2007, with single-family permits down 29 percent and multifamily permits down 9 percent for the year. The total decline from the 2005 peak was 35 percent, including a 42 percent reduction in single-family permits. 

•  The report said that it’s hard to gauge with certainty how far home prices have fallen, as each of the three most commonly used measures paints a different picture.

How does the current downturn stack up against others in recent memory?

• The 12 percent drop in national home prices since the October 2005 peak (18 percent in real terms) exceeds the downturns of the early ’80s and early ’90s.

• At current interest rates, the national median price would have to fall an additional 12 percent from the end of 2007 to bring the monthly payments on a newly purchased median-priced home back to 2003 levels, the report said. In 40 metros, prices would have to fall more than 25 percent.

The boom-bust housing cycle has been reflected in the home-ownership rate. From 1994 to 2004, the home-ownership rate surged by five percentage points, peaking at 69 percent. Since then, home-ownership rates have fallen back for most groups, including a nearly two-point drop among black households and a 1.4-point drop among young households. The number of renter households increased by more than 2 million from 2004 to 2007, lowering the national home-ownership rate to 68.1 percent.

THE FUTURE: Once the oversupply of housing is worked off and home prices start to recover, the use of automated underwriting tools, a return to more traditional mortgage products, and the strength of underlying demand should put the number of homeowners back on the rise, the report said.

• Minority Growth: The minority share is likely to reach about 35 percent by 2020, the report said. The report projected that minority household growth among 35- to 64-year-olds should remain strong in 2010-2020, while the number of white middle-aged households will begin to decline after 2010 as baby boomers reach retirement age.

• Singles and/or Senior Growth: People living alone are expected to account for 36 percent of household growth between 2010 and 2020, and 75 percent of the 5.3 million projected increase in single-person households will be among those 65 and older.