In an oversight report released February 10 titled Commercial Real Estate Losses and the Risk to Financial Stability, the Congressional Oversight Panel (COP) found that an expected surge in commercial real estate loan failures over the next few years could significantly harm America’s weakened financial system and, among other things, destabilize the lives of thousands of tenants in multifamily buildings.
Commercial real estate loans are those taken out by developers to purchase, build, and maintain real estate such as shopping centers, offices, hotels, and multifamily properties. Because commercial loans typically balloon after a short-term period of just a few years, loans need to be refinanced on a regular basis.
According to the report, banks and other commercial property lenders bear two primary risks: either that a borrower may not be able to pay interest and principal during the loan’s term, or that the borrower may not be able to get refinancing when the loan term ends. In either case, the loan will default and the property will face foreclosure.
The authors estimates that between 2010 and 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms, the period in which the remaining balance of the loan becomes due. Currently, nearly half of these loans are “underwater,” meaning the borrower owes more on the loan than the underlying property is worth, and will not be able to be refinanced in the usual manner, putting them at risk of default and foreclosure. The report finds that the loans most likely to fail are those made at the height of the real estate bubble, when commercial real estate values had been driven above sustainable levels.
A wave in commercial mortgage defaults would jeopardize the stability of many banks, specifically the nation’s mid-sized and smaller banks, which the report finds are highly invested in commercial loans. In addition, a surge of defaults would also trigger painful economic repercussions that could result in direct job losses.
Further, the Panel worries that foreclosures on apartment complexes could push families out of their residences, even if they had never missed a rent payment. Though owners and purchasers of larger multifamily units are less likely to actively evict tenants prior to foreclosure and resale, and the Protecting Tenants from Foreclosure Act provides an additional measure of protection for affected families, the uncertainty of ownership and the lack of investment in the period in which the property is distressed could likely to lead to the deterioration of services and of the properties themselves, significantly injuring tenants’ quality of life.
In response to the escalating economic crisis, Congress created the COP in October 2008. COP is authorized to hold hearings, review official data, write reports on actions taken by Treasury and financial institutions, and is empowered to review financial markets and the regulatory system.
Along with its analysis of the risks in commercial real estate, the report also provides a very useful description of the commercial real estate finance system and its history.
Access the report and additional information at: http://cop.senate.gov/reports/library/report-021110-cop.cfm