Commercial-space loans going bad

Owners of shopping malls, hotels and offices are defaulting on their loans at an alarming rate, and the commercial real estate market is not expected to hit bottom for three more years, industry experts warned yesterday.

"The commercial real estate time bomb is ticking," said Rep. Carolyn B. Maloney, D-N.Y., who heads the congressional Joint Economic Committee.

Delinquency rates on commercial loans have doubled in the past year to 7 percent as more companies downsize and retailers close, according to the Federal Reserve. Small and regional banks face the greatest risk of severe losses from commercial real estate loans.

The commercial real estate market's fortunes are tied closely to the economy, especially unemployment, which hit 9.5 percent in June. As people lose their jobs or have their hours reduced, they cut back on spending, which hurts retailers, and take fewer trips, which hits hotels.

Funding for commercial loans virtually shut down last year as the financial system unraveled. Industry executives say financing is still extremely difficult to obtain, even for financially healthy properties.

Though that may seem like an abstract problem, it has real-world consequences.

New construction projects have come to a virtual standstill. That means reduced tax revenue for local governments and fewer construction jobs, said Jeffrey DeBoer, chief executive of the Real Estate Roundtable, an industry group.

The commercial-property industry is "not going to turn around until consumers and businesses start spending money again," he said.

Total losses in securities backed by commercial property loans could be as high as $90 billion in the coming years, according to Deutsche Bank analyst Richard Parkus.

Even more losses -- up to $140 billion -- are expected from construction loans made by regional and local banks, rather than those sold as securities held by investors, he said.

"We believe the bottom is several years away," Parkus told lawmakers.

In the Richmond area, the overall office-vacancy rate increased to 16.4 percent at the end of the second quarter, up from 15.5 percent at the end of the first quarter, according to a report released earlier this week by Henrico County-based commercial real estate brokerage Grubb & Ellis/ Harrison & Bates Inc.

"Both owners and tenants are adjusting to the new reality and accepting that recent market weakness is not just a blip," the report said.

The most notable issue, the report said, is the 300,000-square-foot Deep Run I building, formerly occupied by Circuit City Stores Inc., that went into receivership. Lexington Realty Trust turned the vacant property over to Bank of America.

Lease negotiations also are testing new lows, the report said. For instance, a 2,000-square-foot lease in the Innsbrook Corporate Center was completed at 22 percent below the quoted asking rate on a five-year term in renovated space.

The report said further contraction is expected in the Richmond office market with more inventory and more upside-down loans, or loans with balances greater than the space's value.

The government this year launched a program intended to spur lending to consumers and small businesses. The program, known as the Term-Asset-Backed Securities Loan Facility, was opened to commercial real estate loans last month.

But the effort has struggled to get off the ground. In mid-June, investors passed on their first chance to buy newly issued securities backed by commercial real estate loans. The government this month is expected to make the program available for existing commercial mortgage securities.

Industry groups are now pushing for the government to extend this program through the end of next year and launch new government programs to support commercial real estate loans.

The pain is already spreading through the economy.

In April, the second-largest owner of shopping malls in the nation, General Growth Properties Inc., buckled under $27 billion in debt and filed for Chapter 11 bankruptcy protection. General Growth owns four centers in Virginia, including Tysons Galleria in Northern Virginia and Lynnhaven Mall in Virginia Beach.

And GE Capital, the financial arm of the conglomerate General Electric Co., has seen its profits from commercial real estate snuffed out in recent quarters.

It went from making $476 million in 2008's first quarter from its portfolio of office buildings, retail centers and manufacturing facilities to a loss of $173 million in the first quarter of this year and warned that losses on its commercial real estate loans and property holdings could reach $6 billion this year.

At the hearing, Jon Greenlee, associate director of the Fed's division of banking supervision, said the central bank is paying extra attention to banks' books as losses from sour commercial real estate loans keep mounting.

He said the Fed has stepped up training of its bank examiners so they are ready to deal with rising losses from the commercial real estate industry.

Asked whether commercial real estate poses a threat to the financial system, he said, "we view it as a very key risk . . . and we have put a lot of emphasis on it."

Deputy Business Editor Gregory J. Gilligan and The Associated Press contributed to this report.