Commercial Real Estate: The Next Economic Shock?

With the economy on uncertain footing, one area of continuing concern is the commercial real estate market, where over a trillion dollars of loans will come due over the next few years. Many of those loans were made at the height of the real estate bubble, and more than half are now underwater, meaning that borrowers owe more than the properties are worth.

Commercial real estate is different from home mortgages, where buyers typically get a 30-year mortgage and then pay a portion each year with the goal of paying off the loan. Commercial loans are refinanced every three to 10 years and normally, that’s not a problem. But with commercial property values down nearly 40 percent since the start of the recession, many of the loans that need to be renewed could be in trouble — and that could send shockwaves through the economy, according to Elizabeth Warren, chairman of the Congressional Oversight Panel.

“A big enough wave of commercial mortgage defaults would trigger economic damage that would touch the lives of every American,” Warren said as she introduced the panel’s findings on the problems in the commercial real estate market. “Empty offices, empty hotels and empty stores could lead directly to job losses. Banks that suffer losses — or fear they might — could grow even more reluctant to lend, which could make it even harder for you to get a loan.”

With more than a hundred stores, five major malls and over $5 billion a year in retail sales, Paramus, NJ, exemplifies how this problem could impact local communities. Chuck Lanyard is the president of The Goldstein Group, the largest commercial real estate broker in New Jersey. Twice a year, his company tallies all the vacant storefronts and his latest survey found over 8 percent of Paramus's retail space unoccupied. Prior to the recession, the average was 2 percent to 3 percent. Lanyard thinks a decade of constant growth has resulted in commercial retail space reaching the saturation point.

“The bottom line is, we have way too much retail,” he says.

The issue is finding new tenants to fill the vacant spaces that don’t compete with already existing businesses. “The concern is still gonna be, how many furniture stores can you really have to compete with in today’s market?” he asked. “Where there’s not enough dollars to go around for those retailers to survive?”

Like the rest of the nation, New Jersey was hurt by the bankruptcies of several big box chains, including Circuit City and Linens ‘n Things. But Lanyard is optimistic as Paramus's vacancy rates are lower compared to other regions in the country. That's a sentiment shared by the borough's tax assessor, James Anzevino. One day while driving through a crowded parking lot at the Bergen Town Center shopping mall, he pointed out that while the economy may be bad, people continue to go to the mall to shop.

In the spring of 2007, Bergen Town Center began a $170 million expansion and renovation. Then the economy soured. But the work continued, and three years later, the construction is nearly complete. Anzevino sees that as a sign of Paramus's strength and resiliency.

“If there was no sign of growth, then I would be a little bit more concerned,” he said. “But there seems to still be activity. There seems to still be a market.”

While some economists don’t expect New Jersey or New York to experience the worst of the predictions about commercial mortgages, there is concern. Vacancy rates for office buildings in Bergen County remain in the high teens, and the delinquency rate for investor-held mortgages is still higher than the national average.

But one possible silver lining real estate executives point to is that lenders know about the problem and have had time to try to correct it. Many banks are now working with commercial borrowers to modify loans and prevent a repeat of the record numbers of foreclosures seen in the housing market.