Is CRE Seeing Light at the End of the Tunnel?

As the 1^st quarter 2010 numbers come in, banks across the country are still uneasy about the short-term outlook for commercial real estate – and their portfolios in particular.  At the same time, there is a growing sense that the potential for disaster has faded and that problems are being resolved.

In general, banks reported that troubled loan assets were moving through their books.  Older construction loans are being converted to term loans, which gives borrowers an opportunity to hang on when cash flow is sluggish.  At the same time, banks are reporting that new non-performing commercial real estate loans were coming in at a slower pace.  Some loans labeled as non-performing were moving into the real estate owned (REO) grouping, meaning that they will eventually be sold back into the marketplace.  The International Monetary Fund’s April 2010 Global Financial Stability Report offers a fairly optimistic point of view for bank losses in the near future, as anticipated write-downs on U.S. bank’s loan and securities books diminished in comparison to late last year.

“These improved short-term losses are due primarily to two factors.  First, signs of an improving economic environment have decreased loss expectations,” said Mark Fitzgerald, senior debt analyst for CoStar Group.  “Second, some write-downs have simply been pushed forward as external factors, including low interest rates, have enabled banks to push off distress into the future.  What are the implications for commercial real estate investors?  The banks supply approximately 50 percent of all debt capital to the sector, so lending capital could be constrained for some time.  However, there is a bright side.  If we continue to follow our current path, and distressed assets bleed slowly into the market over time, then healthy lenders may have enough capacity to meet low transaction volumes (especially with depressed pricing).  The large banks that have recently reported healthy earnings (primarily due to their trading and fixed-income operations) are a potential source of capital, and these banks have historically been under-allocated to commercial real estate compared to the overall banking sector.”