The Other Shoe Is Dropping

The housing depression has been bad enough, but far less attention has been paid to its corporate counterpart in commercial real estate. The bad news is that the commercial real estate market is plunging almost as badly as the residential one, and it too is about to hit crisis mode.

Vacancy rates in office buildings exceed 10 percent in virtually every major city in the country and are rising rapidly, a sign of economic distress that could lead to yet another wave of problems for troubled lenders.

With job cuts rampant and businesses retrenching, more empty space is expected from New York to Chicago to Los Angeles in the coming year. Rental income would then decline and property values would slide further. The Urban Land Institute predicts 2009 will be the worst year for the commercial real estate market “since the wrenching 1991-1992 industry depression.”

Banks and other financial companies have not had the problems with commercial properties in this recession that they have had with residential properties. But many building owners, while struggling with more vacancies and less rental income, will need to refinance commercial mortgages this year.

The persistent chill in lending from banks to the credit markets will make that difficult — even for borrowers who are current on their payments — setting the stage for loan defaults.

The prospect bodes ill for banks, along with pension funds, insurance companies, hedge funds and others holding the loans or pieces of them that were packaged and sold as securities.

Jeffrey DeBoer, chief executive of the Real Estate Roundtable, a lobbying group in Washington, is asking for government assistance for his industry and warns of the potential impact of defaults. “Each one by itself is not significant,” he said, “but the cumulative effect will put tremendous stress on the financial sector.”

The commercial real estate market collapse is the main reason why I believe recovery in the economy is several years off. Even if the residential market turns around in 2010, the commercial market still has a long way to go to daylight. Ten percent vacancy rate is horrifying, and it's going to get far worse, causing another round of bad bank problems and massive corporate defaults on property, triggering another round of bailout cash pleas for the business sector.

It's going to get far, far worse before it gets better.