Will Commercial Real Estate Be the Next U.S. Financial Disaster?

Lately, even the mainstream media in the United States are overdosing on apocalyptic reporting.

Once you’ve covered a global financial meltdown, a global swine flu pandemic, the bursting of the largest residential real estate bubble in memory, the prospect of bankruptcy at two of the Big Three auto manufacturers, U.S. policies on torture (and its salient drawbacks and rewards), and the spectre of thermonuclear war waged by any of a handful of rogue nations currently run (or about to be run) by insane persons, you do start to get a little jaded.

What else could possibly go wrong?

How about a tidal wave of tanking U.S. commercial real estate loans?

Last Thursday, General Growth Properties, the nation’s second largest owner of commercial shopping malls, filed for Chapter 11.

That makes GGP the largest retail bankruptcy to hit the U.S. thus far.

Some analysts are predicting (and have been for some time now) that commercial real estate will be the next catastrophic U.S. financial event, the next big bubble to burst. Already, over the course of only a few months, a number of major retail businesses have gone belly up in the United States; including formerly prosperous big box stores Circuit City, Linens & Things, and Dave & Barry’s.

Commercial loans account for only about half the dollar amount of residential mortgages, but unlike residential mortgages, commercial loans typically come up for renewal on a five year cycle. With commercial real estate values dropping rapidly and commercial credit tightening up to reflect liquidity challenges at major banks, more and more businesses are finding lenders unwilling to renew their contracts.

Even so, some property managers believe the commercial market won’t ever get as  bad as the residential market, because property values never got as far out of whack as they did with residential mortgages. Currently banks have about $1 trillion worth of exposure to commercial real estate loans, but it’s unlikely that all of them will go bad.

Circuit City, a U.S. big box retailer of home electronics, filed for Chapter 11 in November of 2008.

“Things are tough in commercial real estate. Values are declining and are likely to continue to do so for awhile,” said Kevin Means, managing partner with Alpha Equity Management, a Hartford, Conn.-based money manager. But Means doesn’t believe the commercial market will tank with the drama that the residential market did.

“…the reason why it won’t be as bad as with mortgages is that residential properties are based on many private decisions of personal home owners who are somewhat driven by emotion,” Means said. “There are wider swings in value than what you see with the more disciplined activity in the commercial market. So there wasn’t as much of a bubble.”

With the second largest chain of malls going under, those words may be less than reassuring to financial pessimists, but only time will tell.

“Historically, commercial real estate is one of the last areas to experience a downturn,” said said Keith Hembre, chief economist with First American Funds in Minneapolis. “Employment is the driver that determines occupancy.”

The unemployment rate in the U.S. stands at 8.5% right now, with many metropolitan areas experiencing 15% or more, and Detroit and the outlying suburbs at 29% and rising.  Growth shrank by over 6% in the U.S. in the first quarter of 2009.  In order for unemployment to moderate, the U.S. would have to grow by at least 3% or 4% per quarter for at least two quarters.

Anyone interested in buying real estate in the U.S. might want to take a ‘wait and see’ approach, at least for the next few quarters.