The Real Estate Bust Is Far From Over
by Doug French by Doug French
For those thinking that the real estate bust is all over with — think again. The residential market has hit the ditch and continues to sink lower, but now the commercial property market is rolling over and will take many lenders down the drain with it. America’s small and regional bankers are pointing their fingers at the big banks, claiming the big money center banks "have tarred and feathered us," City National Bank chief executive Bill McQuillan told the Wall Street Journal during the Independent Community Bankers of America convention in Phoenix. But banks — large and small — all over the country are loaded with commercial real estate loans, and that collateral is heading south according to a Deutsche Bank report.
The folks at Deutsche Bank see price declines of 35 to 45 per cent and maybe more in commercial property, due to the large number of loans coming due between now and 2012 that will not be able to be refinanced. Not only are loan delinquency rates up and rents down, but the go-go years of aggressive loan underwriting are gone. The interest only, high low-to-value loans that drove capitalization (cap) rates to the five percent range are history. Property buyers who are required to put more money down will offer significantly less for the same net operating income to achieve the required return on investment. Thus, cap rates for properties in Las Vegas, for instance, are closing in on 9 percent according to a local appraiser and may be one their way to 10 percent.
But bankers are in a state of denial, according to real estate pro Andy Miller, who spoke at Doug Casey’s Crisis & Investment Summit in Las Vegas recently. Miller’s been in the business for 30 years and hasn’t seen a property financing market this tight. But the current note holders are saying "don’t worry, be happy." Miller told the capacity Casey crowd that bankers show him the door when he rains on their parade.
Despite being inexperienced and clueless, at least bank workout officers understand what’s going on, according to Miller, however the rose-colored glasses-wearing bank senior managements are counting on real estate values to turn around by year end. It’s the same sort of denial Miller saw during the S&L debacle. Eventually there was capitulation, but it took years. A Vegas appraiser who lived through the 1980’s Texas property meltdown echoes Miller’s view, remembering that it took property owners in Texas back then years before they figured out that their property values weren’t coming back any time soon.
The conventional wisdom is that people losing their homes will rent an apartment so apartments are a safe place for real estate investment dollars. Miller’s view is just the opposite, thousands of empty houses compete with apartments and a gigantic multi-family implosion is coming. The numbers in Deutsche Bank’s report confirm that the apartment implosion is already underway. The total current delinquency rate for apartment loans is 3.53 percent, much higher than the last peak in delinquency of 2.35 percent back in October of 2005. And the past due rate on new apartment loans are especially bad at over 5 percent. Tennessee, Georgia and Florida top the multi-family most delinquent list.
But no area of commercial property will be spared the bloodbath. Hotels are imploding according to Miller and cap rates for retail properties have jumped 250—300 basis points in a year, while office cap rates have increased 200 basis points. These cap rate increases translate to property value decreases of a quarter to a third, and the market is just starting to deteriorate. This property meltdown will "make the 1980’s look like a picnic," Miller says.
There will be tens of billions of dollars in losses in the Las Vegas condo market, Miller told the Casey faithful while pointing at the nearby Las Vegas Strip. But Sin City won’t be alone. The U.S. had 14 months worth of condo inventory at the end of last year and the 93,000 units scheduled to be finished this year will increase inventory 28 percent. A good share of those units — 12,000 — will come on line in job bleeding New York and northern New Jersey, reports the Wall Street Journal, while the Windy City will have an additional 5,500 units for sale and Miami will add nearly 3,500.
The condo crash is making life miserable for Donald Trump, who has projects in many of the once hot and now not markets. He’s fighting with his lenders in Chicago, has only closed sales on a quarter of his finished units in Las Vegas, and buyers in two projects in Miami bearing the Trump name aren’t showing up to close escrow.
But, The Donald is keeping the sunny side up. As for his Vegas tower, “We are doing very nicely considering that Las Vegas is in a massive depression,” Trump told the Wall Street Journal.
On the housing front, there was a nearly 10 month supply of unsold homes on the market at the end of February while the Case-Shiller home-price index plummeted a record 19 percent in January, causing David Blitzer of S & P’s index committee to say, "There’s no daylight that I can see in this report." But national homebuilder Pulte Homes must see daylight in their crystal ball. The company announced it will buy competing builder Centex.
“We believe this is the right combination at the right time in the business cycle," Centex Chairman and Chief Executive Officer Timothy Eller, said in a statement. "By acting decisively now, we’re creating unrivaled firepower to capitalize on the opportunities in home building that are now becoming visible on the horizon."
Lenders aren’t the only ones in denial.
Doug French [send him mail] is executive vice president of the Ludwig von Mises Institute and associate editor for Liberty Watch Magazine. He is the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.