Commercial Real Estate Faces Battering

The defaulting on loans last week by the owners of the two largest apartment complexes in New York served as a vivid reminder of the weakness of the commercial real estate market. The downturn in commercial real estate could ripple throughout the economy.

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The owners of two huge apartment complexes in New York turned in their keys last week and walked away, defaulting on their loans, and that was a vivid reminder of just how weak the commercial real estate market is. From Hartford and Dayton to Phoenix and the West Coast, vacancy rates are high, and as NPR's Wendy Kaufman reports from Seattle, the downturn in commercial real estate could ripple through the whole economy.

WENDY KAUFMAN: Everywhere you look, you see signs that read: For Lease - in retail malls, suburban office parks and prime downtown buildings. Walk through the revolving doors of the casually elegant mid rise at Second and Seneca in downtown Seattle, and you'll find great spaces with fabulous views. Right now, says Jim Allison of Kinzer Real Estate, the rents are very attractive.

Mr.�JIM ALLISON (Kinzer Real Estate): At the peak of the market, you were talking about something with a five in front of it, so $50 a square foot. Now you're probably talking more in the order of $30 to $32 a square foot.

KAUFMAN: In other words, about 40 percent less than it was a couple of years ago. With too much space and too few occupants, building owners are doing whatever they can to lure tenants in and keep them. Craig Kinzer, who's Allison's boss, negotiates real estate deals for major corporate and public clients. He says in addition to rent reductions, landlords are offering things such as 20-year leases with only modest penalties if you decide to leave sooner.

Mr.�CRAIG KINZER (Kinzer Real Estate): You have the best of all worlds. If you like the space, you have it at very low rates, which will make you much more competitive than others in your same industry in 10 years or so, but if you outgrow the space, or for some reason it doesn't work, you terminate and you leave.

KAUFMAN: And Seattle's commercial real estate market isn't unique. Almost everywhere in the country vacancies are up and rents are down. Supply and demand are out of whack.

In this economy, many businesses want less space, not more. At the same time, the amount of space available has grown dramatically. Why? Matthew Gardner(ph), a land-use economist, explains: It takes a long time to build a large commercial project.

Mr.�MATTHEW GARDNER (Land-Use Economist): You can be looking at a project back in 2003, 2004, and the market obviously was very ebullient, every buoyant, but that project wasn't going to be delivered until 2008 or 2009. So when you're looking at a five-year time horizon between we think we should build a product and it being delivered, much can change economically.

KAUFMAN: And it has, adding up to huge challenges for landlords and their lenders. With less rent coming in, landlords can't always make their mortgage payments. And there's another problem. As Stan Ross, chairman of the University of Southern California's Center for Real Estate explains, commercial loans are typically refinanced every five years.

Mr.�STAN ROSS (Chairman, Center for Real Estate, University of Southern California): Normally, that would not be a problem. You go into the market, refinance, and everything would be fine. In today's market, the challenge is you can't get new financing as you did in the past.

Mr.�KINZER: Well, the FDIC, the federal government saw that coming and said, oh my gosh.

KAUFMAN: Craig Kinzer says banking regulators are worried that borrowers who can't refinance may simply default on the loan, or if their mortgage is more than the property is worth, they might simply decide to walk away from the loan completely. The banks would have to sell the properties at a loss or put them into a bucket of bad loans.

When banks have bad loans on the books, they have to increase their reserves. Kinzer says the FDIC knew many banks didn't have the cash to do that, and regulators didn't want to shut down all those banks. So last fall, banking regulators relaxed some of the rules.

Mr.�KINZER: The FDIC said, hey, there's just way too much of this stuff. Let's change the rule. Let's tweak it a little bit so that we don't get as many loans going in that bad bucket, even though we all know it probably should go there.

KAUFMAN: So just how big a problem is all of this? Expert opinion varies, but it's fair to say that if banks are worrying about bad commercial real estate loans, they are less likely to lend money to the rest of us, and the economy might not grow as fast as it otherwise would. Wendy Kaufman, NPR News, Seattle.

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