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Why Real Estate Will Hold The Economy Back
This article originally appeared in The Daily Capitalist.
Commercial real estate loans and residential housing will continue to be a significant drag on economic performance. Until the mass of over-built homes and commercial properties are liquidated credit will remain tight and unemployment will remain high.
The unfortunate fact remains that credit for most of America is still tight, banks are still trying to repair their balance sheets, and the overlying problem is real estate, the detritus of the Fed's reckless monetary policy. Credit expansion fueled by the Fed's easy money policy of the early 2000's drove private debt to fuel housing over-production, and drove commercial debt to fuel commercial real estate (CRE) over-production. It was the greatest such expansion of money and credit the world has ever seen and it went primarily into real estate. We are now facing the consequences of that expansion and boom: the bust.
The FDIC released its Q4 report on the health of our banking system and while banks are improving, credit is restrictive as evidenced by sluggish loan growth.
Total lending fell for the ninth time in the past 10 quarters, with the largest reduction in real-estate construction loans and non-credit-card consumer loans, the FDIC said. Credit card and home mortgage lending grew. Total loan and lease balances fell 0.2%, or $13.6 billion, while total assets for the industry fell 0.4%, or $51.8 billion. Real estate construction and development loans were largely responsible for the overall loan decline, falling more than 9%.
The problem with the data is that most of the positive news was restricted to the big money center banks. However the FDIC did report that 62% of all banking institutions (7,657 of them) turned a profit in Q4. Most of their bottom line improvement wasn't related to loan growth but rather to loan write-offs. As banks report loans to be in default, they are required to reserve a certain amount of funds to account for the loss. But, once the losses are taken or the loan is otherwise resolved, the reserves move back into the revenue side of the ledger and boost earnings.
Much of the year-over-year reduction in provisions was concentrated among some of the largest banks. Seven large institutions accounted for more than half of the $31.3 billion reduction. However, a majority of insured institutions (54 percent) reduced their provisions in the fourth quarter compared to a year ago."There is a limit to the amount that smaller loan-loss provisions can contribute," to banks' bottom lines as revenues remain stagnant, [FDIC Chair Sheila] Bair said. "A key reason why revenues haven't grown faster is that loans have not been growing."
But, the positive is that reserves requirements are being reduced as banks deal with bad loans:
Insured institutions set aside $31.6 billion in provisions for loan losses in the fourth quarter, almost 50 percent less than the $62.9 billion they set aside a year earlier. This is the smallest quarterly loss provision for the industry since third quarter 2007.
The FDIC said that they currently have 884 banks on their"problem list." Bank failures in 2010 were the highest in 18 years (157 failed, another 197 were "absorbed" through forced mergers).
In a further sign that we are not out of the woods yet, the FDIC extended their full guarantee of non-interest bearing deposits, the TLGP program (i.e., on top of the $250,000 guarantee).
The other side to this issue is that businesses, especially small businesses which employ about one-half of the workforce, are not borrowing, contrary to what some of the big banks are reporting. A recent survey by the National Federation of Independent Business (businesses employing up to 250 employees) reported:
Though most small businesses use credit of some kind, more than half said they didn't need any new loans last year, according to the survey. Of those who applied for loans, 41% got what they needed, 16% didn't get any credit, while the rest obtained some. A small number of businesses rejected the credit they were approved for because they didn't agree with the terms. The survey also found that business owners who use credit cards as the only source of borrowing do so by choice rather than because they didn't get a bank loan.
"The economic atmosphere for small businesses did not improve much in 2010," said Denny Dennis, NFIB Research Foundation senior fellow, in a press release. "We don't expect credit levels to reach the levels they did a decade ago."
Which is one of the reasons jobs growth is sluggish as well.
One may ask why businesses aren't expanding and borrowing. The obvious answer is that they don't see sufficient demand to warrant expanding and borrowing. (We will discuss the current producer indices in another article.) Another less obvious answer is that a lot of small business owners were negatively impacted by the decline in real estate.
The NFIB report was quite revealing. The bottom line is that one-half of survey respondents who wanted credit couldn't get loans, especially the credit lines that so many small businesses rely extensively on. And, unlike large businesses, these people have no real alternatives.
Why? It turns out that small businesses owners own homes, the buildings in which they do business, and have made real estate investments:
These assets were a substantial part of their net worth and as real estate has collapsed, their ability to borrow was substantially impaired. As the report concludes:
The more serious issue affecting creditworthiness is real estate. Small business owner possession of real estate is a major reason why their firms have not yet begun to recover, why larger businesses have been able to recover more quickly than small businesses, and why this recession is different, at least for small business owners, from recent ones. It has damaged balance sheets and they will need to improve before small business can be expected to resume its traditional place in the economy.
I need not remind you of the problems with housing (see "Woe Is Housing").
CRE is not much better: it is continues to decline. While some of the trophy and "A" class properties are finding buyers, the rest of the market, the types of properties that most small investors own are not faring well. One way to follow the CRE market is to follow the commercial mortgage backed securities (CMBS) secondary market. It isn't good. This is the 30 day+ delinquency report from Trepp:
Moody's CRE price index remains gloomy:
What all this means is that the majority of banks who hold CRE (most loans below trophy and investment grade are held by local and regional banks) still have a long way to go before their balance sheets have been resolved. While the trend is improving, these banks have yet a lot of loans to work off.
On the other side of the loan window, small business borrowers, those who employ one-half of U.S. workers, have problems of their own with housing and CRE values continuing to decline. When one looks at the overall problem these entrepreneurs have, the question of why they are not borrowing or not obtaining credit is not difficult answer.
It isn't as if there isn't progress in writing down loans by banks. Loan writedowns are finding their way onto the markets as foreclosed properties, thus continuing to depress CRE markets across the country. According to Costar, "Distress sales as a percent of the total has been increasing in each of the four quarters in 2010 with just over 20% in the 4th quarter with 18.5% for all of 2010."
We have a long way to go until our economy recovers. Until the malinvested real estate from the boom phase has been liquidated, the economy will continue to stagnate and unemployment will remain high.
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Soon is a relative term. I think in two years we will be seeing a high inflation and in five we will look on today's prices the way we look at old photos showing gas for 35 cents. I really hope I'm wrong. The rental units I manage have taken a 10-15% hit in rent in the last couple years and if good renters want to negotiate a discount when they sign a new lease they get it. The up side is that getting good renters is much easier now. Foreclosed homeowners make excellent renters if you can look past their credit scores. Just have to keep your fingers crossed they stay employed, new jobs are a bit scarce.
the hell with it all - just open up a SNAP-Day Loans kiosk and start skimming interest on their foodstamps
I bet we stop at 70 and rents hit 2000 for a dangerous minority neighborhood apartment. that's not a bad place to put a top in mortgage defaults.
the upper class neighborhoods could end up looking like prisons with armor, barbed wire, alarms, cameras and everyone armed to the teeth (hint:cut off the water...that'll flush em out)
A "prepared" place will have a well and a propane or diesel generator. Maybe even a "Bison" or "Simple Pump" for when the generator fuel runs out.
have you seen Gasland??? you better be high near a snowcap if you want free fresh water
Yes. Not a problem here in NH, yet.
Just thinking, i wonder if you could seperate the water from the gas with a gas powered distiller/condenser?
what about all that fracking fluid mixed into everything?? that's the real problem - not the 'light the faucet' parlor trick
107 months of inventory WSJ reported about 6 months ago. Since then, builders have added thousands of more surplus and the FHA has continued with its almost "nothing down mortgages."
Add to that stagnant wages, massive fraud in the businesses related to RE, what I see is continued "correction" downward for years to come. IN fact, no one I know wants a house anymore and the people I know who own one wish they could sell theirs due to soaring taxes, repairs, utilities, etc.
Buy Hard Assets (like oil, silver, gold, etc) instead imo.
I have a friend who is a realtor and she tells me people only want new houses so there is no maintenance. They hold their prices better for the subsequent ten years and have lower operating costs than older houses.
Older houses (like mine) no one wants without a huge discount. This is why builders can keep building.
The same situation is happening here in Scottsdale, AZ. Three people I work with bought brand new houses, as opposed to buying bigger older houses.
They didn't want to deal with the "who" really owns the mortgage situation mess, paperwork.
I don't see that here in Bellingham, WA . The close in older houses are far more coveted than those in the cookie cutter new developments. Anecdotaly I know of two recent sales of fairly priced homes in older neighborhoods both with full price offers within 3 days. Location, etc.
Having been a real estate lender in Texas in the mid 80's, I have seen first hand what constitutes the bulk of commercial real estate in community or regional banks. It usually is not income producing properties but rather it is RAW LAND. It produces no income, unless there is an end user. It is usually financed for 12 to 24 months with the expectation that the interest will be rolled into another 12 to 24 note. Generally, it can be a liability if can not be sold due to recurring taxes, maintenance such a mowing, continuing interest accrual and worst of all NO INCOME. Land prices have experienced the same unstustainable rise as homes, income producing properties, apartments, etc. Where the banks will really get killed is when the interest rates on non income producing, overleverage raw land rises from 3% to 6% or 9%. That will be immediate death for leveraged raw land holders and subsequent death for community banks.
This is an excellent point.
I don't know about TX but in Las Vegas raw land has a huge negative value when you consider the cost of constructing anything vs. the current sale prices. A typical 5 ac. well positioned industrial parcel would have to see its seller contribute close to $2M to the potential buyer for the transaction to make financial sense, especially when you take the cost of development and construction into account.
If a developer put 50% down on the property three years ago and it's now worth 80% less, its not hard to see why they're willing to hand the deed over in lieu of of foreclosure. This hurts the community banks and contributes to their being seized by the FDIC. The FDIC then bundles these property and sells the assets to huge outfits like Lennar who get 10 years sweetheart deals to manage the portfolios, so they are more than willing to sit on these parcels until the cows come home - with the idea that they'll be able to sell it for a windfall when the market cycles back up.
If someone was conspiratorially bent, then they might see that huge amount of property had been taken away from a lot of private individual owners and transferred into the hands of big Wall Street firms for pennies on the dollar. But that would be crazy, wouldn't it?
I work in the outskirts of a small northeaster U.S. city. In the late 90's, a 4 story commercial office building was built nearby. The 4th floor has never been occupied. In 2000, another 4 story office building was built 200 yards away. To my knowledge, only the 1st floor of that building was ever occupied. The rents for those buildings have only increased, not dropped, over the last 10 yrs.
One possible positive outcome from high gas prices and falling real estate values may be seen in the outerburbs. Could see "raw land" returning to agriculture and pause on "growing houses". Painful for many folks, but on a macro and long-term basis, could be a very good shift.
hope so. we need that bad
Focusing on real estate while Congress continues to spend like drunken sailors with 20 minutes left on shore leave seems akin to worrying about how your herb garden is doing while the rest of your city clears the shelves at the grocery store.
Everything's irrelevant at this point, except food/water/ammo/PMs. Grab your balls people, this is going to hurt a little.
the land prices WILL decrease.
http://covert2.wordpress.com
If you are in the uk geoff then you will need your list there.
Especially as many of the underclass, the socialists have 'bred', have access to guns from eastern europe. With the law and order breakdown and bastard judges... good luck geoff.