Commercial Real Estate Shoe Is Falling

Minyan Peter, former treasurer for a major US bank is taking a stab at answering Minyan Mailbag: Is Commercial Real Estate Next?

Peter,

I"ve seen a fair amount of debate about whether or not Commercial Real Estate is the "next shoe" based on the evidence that CMBS spreads are widening and with a potential recession, corporate borrowers are going to become worse credits.

Most of the CRE bearishness is of the blogging/doom-and-gloom nature, I thought maybe you could provide a bit more of an analytic approach based on the structural similarities and differences of the two markets.

Thanks
Minyan James


James,

While I am not at all an expert on Commercial Real Estate, I have to believe that it too will be hit badly by the credit crisis for one simple reason - asset deflation. As you probably have read, I am clearly in the asset deflation camp - which I see as the simple consequence of a higher cost of capital coming from a return to risk premia by credit investors.

Having said that, I think that commercial real estate market , like the LBO market, like the stock market is still in the "decoupled" mindset - where corporate earnings can grow despite a slowdown in consumer spending. Like this current stock market rally, denial is a hard thing to fight. But I would argue (am arguing) that we are either in or will shortly be in recession and with it will come further asset deflation. And this time the corporate world will be hit. When that happens, I believe we will move from denial to panic. Then watch out.

So yes I think you are spot on with commercial real estate. Whether anyone will listen...?

- Minyan Peter

Blog Anecdotes

The following is a comment from "KIA" on recent blog entry. I cannot verify the facts but the comment is both believable and interesting:

In two different jurisdictions on Northern Virginia today, I personally observed hundreds of thousands of dollars in judgments being entered on defaulted commercial leases. This is in an area which is generally seen as "recession proof" due to huge federal government spending, yet on case after case, there was $60,000.00 default on one, a $40,000.00 default on the next and so on.

If I had to guesstimate, I"d say there were probably at least $300k in commercial rental defaults per jurisdiction (and we are drawing a distinction between commercial and residential - - it"s standing room only in the courtrooms for the residential evictions).

This has been going on for weeks and there is no reason to think it won"t continue for the forseeable future. Small businesses are evaporating and their disappearance is costing the landlords dearly. This will have consequences.

The anecdotal evidence, Minyan Peter"s comments, and a story I posted on November 28th called Commercial Real Estate Market Is Imploding all suggest the same thing: The Commercial Real Estate Shoe is indeed falling.

IYR Weekly Chart

Here is the IYR Weekly Chart I posted on November 28.



click on chart for crisper image

IYR Weekly Chart As Of December 8th



click on chart for crisper image

Well there is the obligatory 200 day moving average bounce right on schedule.

Are we heading to new highs or is a great shorting opportunity coming up? Fundamentally we know the answer.

Peter suggests the question is "Whether anyone will listen...?" That"s a good question but an arguably better one is "When does it matter?" because just like residential, everyone should know that it eventually will.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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