Submitted by Jim Quinn of The Burning Platform
Consumer Deleveraging = Commercial Real Estate Collapse
There is a Part 2 to the story of Consumer Deleveraging that
will play out over the next decade. Consumers will deleverage because
they must. They have no choice. Boomers have come to the
shocking realization that you can’t get wealthy or retire by borrowing
and spending. As consumers buy $500 billion less stuff per year,
retailers across the land will suffer. To give some perspective on our
consumer society, here are a few facts:
- There are 105,000 shopping centers in the U.S. In comparison, all of Europe has only 5,700 shopping centers.
- There are 1.2 million retail establishments in the U.S. per the Census Bureau.
- There is 14.2 BILLION square feet of retail space in the U.S. This
is 46 square feet per person in the U.S., compared to 2 square feet per
capita in India, 1.5 square feet per capita in Mexico, 23 square feet
per capita in the United Kingdom, 13 square feet per capita in Canada,
and 6.5 square feet per capita in Australia.
Despite the ongoing recession and the fact that consumers must reduce
their spending over the next decade, irrationally exuberant retail CEOs
continue their death march of store openings. Below are announced
expansion plans for some major retailers:
- GameStop – 400 new stores
- Walgreens – 350 new stores
- Dollar General – 315 new stores
- Ashley Furniture – 300 new stores
- Target – 128 new stores
- Starbucks – 100 new stores
- Best Buy – 55 new stores
- Kohl’s – 50 new stores
- Lowes – 45 new stores
Retailers expanding into an oversaturated retail market in the midst
of a Depression, when anyone without rose colored glasses can see that
Americans must dramatically cut back, are committing a fatal mistake.
The hubris of these CEOs will lead to the destruction of their companies
and the loss of millions of jobs. They will receive their fat bonuses
and stock options right up until the day they are shown the door.
All of the happy talk from the Wall Street Journal, CNBC and the
other mainstream media about commercial real estate bottoming out is a
load of bull. It seems these highly paid “financial journalists” are
incapable of doing anything but parroting each other and looking in the
rearview mirror. Sound analysis requires you to look at the facts, make
reasonable assumptions about the future and report the likely outcome.
Based on this criteria, there is absolutely no chance that commercial
real estate has bottomed. There are years of pain, writeoffs and
bankruptcies to go.
Let’s look at some facts about the commercial real estate market and then assess the future:
- The value of all commercial real estate in the U.S. was approximately $6 trillion in 2007 (book value, not market value).
- There is approximately $3.5 trillion of debt financing these commercial properties.
- Approximately $1.4 trillion of this debt comes due between now and 2014.
- The delinquency rate for all commercial backed securities exceeded
9% for the 1st time in history last month and has more than doubled in
the last 12 months.
- Non-performing loans are close to 16%, up from below 1% in 2007.
Do these facts lead you to believe that the commercial real estate
sector has bottomed, as stated in the Wall Street Journal? The Federal
Reserve realized the danger of a commercial real estate collapse to the
banking system over a year ago. They have encouraged banks to extend and
pretend. The website www.MyBudget360.com describes in detail what has occurred:
What has happened is the Fed has
allowed this shadow monetization of the debt and banks let borrowers
roll over CRE debt without even making payments in many cases! Think of
an empty shopping mall. There is no buyer for this in the current
market. So why would a bank want to foreclose on the borrower?
Instead, they pretend the asset is worth $10 million while the borrower
makes no payment and the Fed keeps funneling money into the banking
system. In the end, the value of the dollar gets crushed and you end up
bailing out the banking system. Commercial real estate has collapsed
even harder than residential real estate. This market is enormous in
terms of actual debt. There is no official bailout on the books but it
is occurring through a slow and deliberate process. Banks know that
they are essentially insolvent and they are dumping this junk onto the
This grim story began between 2004 and 2007. The horrifying ending
will be written between 2011 and 2014. Commercial real estate loans for
office buildings, malls, apartment buildings and hotels usually have 5
to 7 year terms. If you thought the debt induced bubble in real estate
only affected residential real estate, you are badly mistaken. Before
the boom, a normal year would see $100 billion in commercial real estate
transactions. Between 2004 and 2007 there were $1.4 trillion of deals
done, with 2007 reaching a peak of $522 billion of commercial real
estate deals. Shockingly, the Wall Street banks, run by MBA geniuses,
loaned developers a half trillion dollars at the very peak in the
market. Sounds familiar. Thank God the taxpayer has bailed these
Einsteins out so they could live to make more bad loans and collect big
Commercial real estate prices rose 90% between 2001 and 2007, driven
by the loose monetary policies of the Fed and complete lack of risk
management on the part of the banks making the loans. Knuckle dragging
mouth breather developers built malls, apartments, offices and hotels
with abandon as billions of dollars rained down on them from Wall
Street. The consumer delusion of debt financed wealth led to the
developer delusion that 100% occupancy and increasing rents for all
eternity were guaranteed.
Commercial real estate prices have dropped 42% in just over a year.
This means that the $6 trillion value of all the commercial real estate
in the country has dropped to $3.5 trillion. The debt remained in place.
The billions in debt issued in 2003 – 2005 is coming due between 2010
and 2012. The underlying assets are worth billions less than the debt
that must be refinanced. Commercial loan payments by owners can only be
made from cash flow generated by rental income. A key requirement in
generating rental income is tenants.
Let’s examine the current state of vacancy rates for offices,
shopping malls and rental properties. The current office vacancy rate of
17.5% is the highest since 1993 and is just below the all-time high
18.7% in 1992. The WSJ has concluded, with no data or analysis, that the
vacancy rate has bottomed. As the employment data proves, companies are
not hiring employees. New companies are not being formed. Government
mandates and regulations regarding healthcare and uncertainty about
taxes will keep the formation of new small companies at a minimum.
Conglomerates continue to ship jobs overseas. Part 2 of this Depression
will drive more companies out of business. Office vacancies will remain
at record levels for the next five years.
Mall vacancies between 9% and 11% are at record levels. There is
absolutely no chance that these vacancy rates decline over the next few
years. With consumers deleveraging, wages stagnant, unemployment high,
and retail oversaturation, there are thousands of retail stores destined
to close up shop. Ghost malls are in our future. They will come in
handy as homeless shelters and soup kitchens. Mall developers will be
defaulting in record numbers.
Apartment vacancy rates peaked at 11% in 2009, the highest level in
history. With millions of vacant homes and millions of available rental
units, rental rates will stay low for years. The cashflow of apartment
developers will under stress and will lead to more loan defaults.
Based upon the current rising delinquency rates of 15.7% for
commercial real estate loans and 9.05% for CMBS, there is no bottom in
sight. Only raging mindless optimists like Larry Kudlow could ignore the
facts and conclude that all is well in commercial real estate world.
Banks pretending that the loans on their books aren’t worth 40% to 50%
less, while also pretending that borrowers with negative cash flow can
make loan payments, is not a solution. It is a Federal Reserve
encouraged fraud. Allowing loans to be rolled over with no hope of ever
being repaid will only prolong the pain and delay the inevitable.
The facts are that hundreds of billions in commercial loans are
coming due, with a peak not being reached until 2013. If banks were to
properly account for the true value of these loans, hundreds of regional
banks would be forced to fail. This is unacceptable to government
authorities. They will insist that the fantasy continue. Banks and real
estate developers will pretend to be solvent, hoping the economy will
miraculously repair itself and eventually make them whole. I understand
these bank CEOs and delusional developers also believe in Santa Claus,
the Easter Bunny, and the Efficient Market theory. It seems our entire
financial system is based upon debt, fantasy, fraud, and delusion.