CRE Still Lagging in the Economic Recovery

There has been some good economic news lately. The Federal Reserve’s Beige Book reported that residential real estate and manufacturing showed signs of improvement. The residential real estate market has been picking up, especially in sales of low-to middle-priced houses, due to the first time homebuyer tax credit. This portion of the economic stimulus has been a key driver in turning around the freefall in housing prices. However, the future is uncertain in this market because the tax credit is due to expire next year.

The tax credit has not benefitted the sale of higher-priced homes which continue to be depressed due to the large numbers of short sales and foreclosures, which are reported to be in excess of 4.1 million.

Commercial real estate was the weakest sector in the report with conditions described as either “weak” or “deteriorating across all Districts”. The report went on to state that “an inability to obtain credit was often cited as a problem for businesses that wanted to purchase or build space.” At the national RMA Conference in Lake Buena Vista Florida on November 9, 2009, Lloyd Lynford, CEO and Co-Founder of Reis, Inc. stated that all four major property CRE sectors (office, retail, apartment, and industrial) are experiencing the “Trifecta of Weakness.” This refers to escalating vacancy rates, declining effective rents, and protracted negative absorption. Vacancy rates are higher for landlords who are not offering concessions. But this practice leads to a significant difference between the “asking rent” and the “effective rent” and results in lower rates for the entire submarket where the property is located.

Not good news for any banker with CRE loans on the books. Robust risk management, especially for commercial real estate loans and including stress testing, is the key.