Is Utah headed for a commercial real estate crisis?

Is Utah headed for a commercial real estate crisis?

KSL.com
March 10, 2010

SALT LAKE CITY -- The Congressional Oversight Panel recently sounded the alarm for another mortgage crisis, this time among the country's retail and office buildings. The panel chairman warns of "significant bankruptcies among developers and significant failures among community banks."

So, does that mean foreclosures in the commercial real estate market deliver another sting from the recession? While national and local analysts say there will be pain, Utah commercial real estate will not take the biggest hits.

Look down Main Street in Salt Lake City, or the business district in your community, and you'll see many signs for available office and retail space. The oversight panel's warning states that "over the next few years, a wave of commercial real estate loan failures could threaten America's already-weakened financial system."

Nearly 3,000 small and mid-sized banks have a risky concentration of commercial real estate loans. The panel fears impending losses could jeopardize the stability of those banks and further weaken the economy.

Nearly $1.5 trillion in real estate loans on the books of those banks needs to be refinanced in the next few years. Commercial real estate values dropped drastically during the recession, so about half of those borrowers owe more than the properties are worth. That makes refinancing troublesome, just as it has been for homeowners upside down in their home loans.

But Zions Bank economist Jeff Thredgold sees a difference between the commercial real estate woes and the housing breakdown.

"There will be some hits, there will be some losses, there will be some problems; but it's not going to be a shock to the system," Thredgold says.

Last year, 150 banks failed. The FDIC has taken control of 20, so far this year, and has 700 banks on its watch list.

"There will be additional bank failures," Thredgold says. "That's typical after a recession, especially the one we just finished."

But Thredgold does not expect the impending foreclosures in the commercial real estate market will cause the kind of economic turbulence experienced when the housing bubble burst.

"Everybody knows the problems in commercial real estate are there," he says. "The banks have been setting aside massive reserves to deal with the problems that are coming. They've been writing down the values of loans and writing down the values of properties that might have already been foreclosed on."

According to CoStar Group -- a Bethesda, Md., real estate research company -- office vacancies in the 12 largest markets range from 15 to 27 percent; in Salt Lake City, only 10 percent.

Ethan Reed is a CoStar senior research manager who studies the Salt Lake Market. He says the fallout here will be much less than in major cities across the country. "Salt Lake City has been an outperformer compared to the national average for at least three or four years now," Reed says.

He cites a stronger-than-average growth rate, more economic stability and lower unemployment than the national average. Salt Lake also gives many businesses a more affordable place to do business.

"In a time when companies are trying to figure out how to save a buck, there are ones looking longer term and seeing Salt Lake City as a low-cost alternative," Reed says.

But across the country, CoStar analysts think the worst is still to come.

"We expect that this distress is going to play out over the next year or two, and then the market will rebound," says Norm Miller, CoStar vice president of analytics.

In part, that's because new construction for commercial real estate stopped. The real estate analyst says banks are restructuring many loans. Real estate investors will lose a lot of equity, but average consumers may feel little pain.

If the federal government forced lenders to foreclose on all loans that are underwater, Miller believes most banks in the country would be insolvent, and we would experience a financial collapse.

But Miller says, "If these loans are able to make the mortgage payments, and we only see foreclosures on the ones that have negative cash flow, then the effect will not be nearly as severe."

Miller says we may not recognize a lot of commercial real estate changes in our communities because eager buyers will pick up distressed properties at a bargain, and keep the office and retail businesses operating.

"Investors are being affected, but at the consumer level, with real estate, buildings don't disappear, and good buildings are still good buildings," he says.

Bottom line: Our analysts do not think the impending commercial real estate troubles will plunge the economy into another round of recession.

E-mail: jboal@ksl.com