Where's the flood?

REVIEW SUMMARY
Industry. Commercial real estate
Trend. Growing number of distressed properties
Key. The first sale may be the best sale.
By The Numbers.
Click here for the total value of distressed properties along the Gulf Coast.
Click here for the amount, number and percentage of delinquent loans by property type at least 30 days late on properties that were funded through commercial mortgage-backed securities on the Gulf Coast.

About $3.1 billion worth of commercial real estate is in distress on the Gulf Coast, but you'd never guess it from the low number of property sales.

Blame lenders and the government.

Banks, bondholders and regulators are waiting for the commercial real estate market to turn around in what appears to be a big game of chicken. Meanwhile, government regulators have no interest in seeing a commercial real estate collapse that might send the economy back into recession.

But an increasing number of commercial property owners are late making payments on their notes because of rising vacancies and declining rents.

“The amount of new distress is going to flow in heavy,” says Andrew Florio, a market analyst with Real Capital Analytics. The firm calculated that distressed commercial real estate totals $2.1 billion in the Tampa Bay area and $1 billion from Sarasota to Naples. That's up 63% from the $1.9 billion in distressed properties on the Gulf Coast at the same time last year.

“Unfortunately, I don't think we're through the cycle with rising delinquencies,” says Matt Anderson, managing director with Foresight Analytics. The firm's parent company, Trepp LLC, reports that 13% of securitized commercial mortgage loans on the Gulf Coast were delinquent in April, up from 4.5% in April 2009. The firm defines delinquency as payments that are at least 30 days late.

Lenders are working their way through foreclosures and attempting to work with borrowers, knowing that selling now would mean taking a big loss. The Federal Deposit Insurance Corp. knows this too. The agency has given banks taking over the assets of failed rivals as long as five years to dispose of distressed real estate.

Why take a loss now when you can delay? “They're looking at an earnings hit that could be quite dramatic,” says Lee Arnold, chairman and CEO of Colliers International in Clearwater.

Banks and the government can't afford to sell now. “The write-downs are massive and the banks that are holding them can't take the write-down because it puts their capital ratios out of whack,” says Timothy Kistel, a commercial broker in Fort Myers. “The FDIC doesn't have any money to cover the loss,” he adds.

As the number of distressed properties grows, observers wonder whether a panic will ensue as lenders and owners decide to sell the assets at deep discounts all at once. “Whether it results in a flood remains to be seen,” says Larry Richey, senior managing director with Cushman & Wakefield of Florida.

The good news is that there are buyers waiting, albeit for prices that are much lower than sellers wish for now. “There is no shortage of capital, but there is a shortage of courage,” says Arnold.

Vacancies and rents may have reached their low point if the economy is indeed improving. “We're not going to see the huge negative absorption in 2010 like we saw in the last two years,” says Richey.

“There is a lot of money in the market right now,” says Ray Sandelli, senior managing director with CB Richard Ellis in Tampa. “The question really is that there's no product to buy.”

Action on the notes
While commercial real estate property sales have been unusually slow, sales of commercial loans have been active. That's because it's often easier and more profitable for a lender to sell the loan rather than go to the expense of foreclosing on a borrower and taking possession of a property.

“There's been a world of transactions going on that are not showing up as real estate transfers,” says Arnold. “Capital is being deployed.”

Investors are eager to get a jump on deals too because they have money that's not earning much in cash now. “They're not waiting for the banks to finish foreclosures,” says Stephen Cunningham, managing partner with LandQwest Commercial in Fort Myers. “It's an extremely active market.”

But buying loans isn't for the faint of heart, especially with larger banks. “It takes 40 phone calls to get to the right guy,” says Cunningham.

Escapades
The lack of commercial real estate on the market now comes down to this: No one wants to take a loss.

“On the bank side, the holdup is that banks are really husbanding their capital as much as they can, which means managing the loss-recognition process,” says Foresight Analytics' Anderson.

Regulators aren't forcing write-downs because of the panic it might create. “The regulators are cognizant that if they marked all the loans to market, they'd have a much bigger problem than they currently have,” Anderson says.

What's more, the FDIC agreed to loss-share agreements that give banks that acquired failed financial institutions as long as five years to deal with distressed assets. “The FDIC is interested in stretching out the process to minimize losses to the deposit insurance fund,” says Anderson. “The question is: Will it be worse than it is today?”

The FDIC itself doesn't seem to be in any rush to sell the assets of failed banks it couldn't sell to acquiring banks. For example, it only has one commercial property posted for sale on its Web site in Fort Myers: A former auto-body shop next to a strip club. Tom Woodyard, a commercial broker in Fort Myers, has it listed for $405,000, or about $50 a square foot.

People who manage commercial mortgage-backed securities, so-called “special servicers,” worry about the same thing. “They're charged with minimizing loss or maximizing value. They're taking a wait-and-see approach,” says Anderson.

Most seem to be ignoring a rule of thumb in banking that your first sale is always your best sale. Waiting to sell usually results in steeper losses later, as banks learned painfully during the residential downturn.

“The white knight isn't going to ride in and solve all the problems,” warns Larry Foster, managing partner with CB Richard Ellis in Fort Myers and Naples. Foster has about 30 properties listed for the FDIC and expects more this year.

Order or panic
In the last commercial real estate downturn of the late 1980s and early 1990s, the government formed the Resolution Trust Corp. to dispose of all the distressed commercial real estate from failed savings-and-loan institutions in an orderly manner.

Without such a mechanism now, some see a more prolonged and gradual disposition of assets over many years, likely prolonging the pain. “The big issue is that the sellers haven't reduced their prices to the market-clearing price,” says Anderson.

“Not many people have panicked,” says Richey. “A steady stream is better than a panic.”

If the economy recovers and building occupancies and rents recover, sellers will have done well to wait. If not, some fear the commercial real estate market could suffer more as empty buildings languish.

“We're looking at a five- to 10-year recovery,” says Kistel. “There's no opportunity for the market to grow and recover.”

There is evidence that more commercial real estate is coming to the market. “They're coming faster and faster,” says Arnold. “There are a lot more realistic sellers out there.”

Although sales are down 30% from the peak, more are occurring. For example, 19 commercial properties of more than $5 million were sold in the first four months of this year totaling $549 million in the Tampa Bay area, according to Real Capital Analytics. That compares with 10 sales totaling $100 million in the same period of 2009.

“The volume coming through hasn't been overwhelming,” says Sandelli. “We're still not quite sure how this whole thing comes out.”