Editor’s Note: This has been talked about for some time as the next “shoe” to drop in this finanical crisis. I have already seen lobbying efforts being put in place to get a bailout package for the commercial real estate industry to refinance these notes coming due into a long-term fixed rate mortgage. According to this article, $30 billion in commercial loans will come due in 2009-10.
News:
Real estate investment trusts (REITs) are leveraged-financed property investments that pervade the commercial real estate market. With the real estate bubble financed by Greenspan’s artificially easy credit policies, these REITs witnessed surging revenues as property values soared. With the collapse of the housing bubble, property values are in free-fall, but unlike residential real estate, commercial real estate hasn’t witnessed mass defaults yet.
Unlike residential real estate, the collateralized debt obligations (CDOs) pervasive in commercial real estate are isolated to a handful of REITs. Mall operators, retailers, and other commercial properties are developed and run by a select few investment trusts, differing from residential housing, which has millions of mortgage bundles across America, many of them already defaulting. This prevents immediate defaults but also centralizes the pain, because as one REIT faces defaults, the others soon follow.
With the weighted average cost of capital (WACC) set to rise 150-200 basis points in response to the credit crisis, cap rates will also increase, causing property values to fall further. This increases default risk as the collateral backing debt obligations loses value, causing borrowing costs to rise further, and restarting the vicious cycle.
As this occurs, REIT clients will be forced to default in mass waves, as they are unable to sell their properties for a decent price and can’t refinance their loans in secured debt markets. About $30 billion of REIT-related debt matures in 2009-2010, and there is very little equity left in REITs to finance the debt.
Some REITs have resorted to suspending cash dividend payments, reverting to stock issuances in their stead. This increases investor exposure to falling property values (expected to be around 30% declines in 2009) and default risks, which could cause more selling as investors flee the overleveraged REITs no longer offering time payments.
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