TOPICS > Economy

Commercial Real Estate May Be Next Victim of Recession

October 6, 2009 at 12:00 AM EDT
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Just two years ago an office space in midtown Manhattan could fetch close to $1.7 billion. Today, the same property trades for about $600 million. A sign the commercial real estate market will be the next shoe to drop in the U.S. economy? Paul Solman reports.

ROBERT WHITE, Real Capital Analytics: There are so many vacancies of retail spaces, former restaurants, other shops…

PAUL SOLMAN, NewsHour economics correspondent: Real estate analyst Bob White, playing Virgil to our Dante on a guided tour of what some fear might become the hellish state of Manhattan commercial real estate — the hotels and stores, apartments and office buildings — that raise the possibility of a next mortgage meltdown.

First stop: Worldwide Plaza, 1.6 million square feet of prime midtown office space, developed by one Harry Macklowe.

ROBERT WHITE: In early 2007, it sold as part of a package of buildings, and this building was priced around $1.7 billion.

PAUL SOLMAN: And what was the deal?

ROBERT WHITE: His organization bought this property and six others for a package deal for around $7 billion.

PAUL SOLMAN: And how much did he put in?

ROBERT WHITE: Well, that’s what’s amazing. Only $50 million, reportedly, was the equity component of that deal. The rest was a combination of a first mortgage and a second mortgage.

PAUL SOLMAN: So $50 million on $7 billion, that’s less than 1 percent down.

ROBERT WHITE: But at the time, the market was full of such optimism that rents would keep increasing and office buildings would stay fully leased. The economy was still growing, banks had a lot of money to lend, and there were many investors that also wanted to be in commercial real estate.

PAUL SOLMAN: But not any more: Great Recession, sky-high unemployment, a glut of office space, so rents fell, building values, too. Meanwhile, the short-term one-year mortgage for Worldwide Plaza came due. Owner can’t refinance; the lenders take over. Resale price?

ROBERT WHITE: It just traded about a month ago for just under $600 million.

PAUL SOLMAN: Wait, it sold two years ago for $1.7 billion and now for $600 million?

ROBERT WHITE: Yes, in very rough numbers. That’s a significant discount, and that is…

PAUL SOLMAN: Significant discount? That’s two-thirds of the price!

ROBERT WHITE: Exactly. The overall market is down approximately 35 percent from the peak. This traded at a more significant discount because it is 50 percent vacant. And in today’s market, vacant space is worth very little.

PAUL SOLMAN: A block away, a further sign of trouble.

ROBERT WHITE: This is a development site. There was a grand tower planned for it, but like many other projects across the country, it’s been delayed right now.

PAUL SOLMAN: Unable to find tenants to fill the planned $1 billion skyscraper, the developer suspended construction, workers protecting the foundation hoping to build another day.

How many sites like this are there in New York?

ROBERT WHITE: There are over 300 in New York alone. And, of course, across the country, every city has lots like this that were planned grand developments that will never get off the ground. When we look at developments sites down in, say, Florida and California, they’re trading at 10 cents, 15 cents on the dollar.

PAUL SOLMAN: Just around the corner, yet another ill omen: feeble consumer spending has spurred a surge in hotel and retail mortgage defaults. The Dream Hotel is past due for $100 million.

It looks like a prospering property. I mean, the restaurant’s open, the hotel is in operation.

ROBERT WHITE: There’s a lot of activity. It looks successful. It’s just not making the same kind of revenue that they projected that they would be making at this point. Therefore, the loan is in default because the loan was also made based on those very optimistic assumptions.

PAUL SOLMAN: So, basically, properties like this just sold for too much money?

ROBERT WHITE: They sold or were financed for too much, not unlike housing, where the buyers would think that their incomes would keep rising. And that didn’t happen and, therefore, they got into trouble. It’s very similar in the commercial sector, as well.

PAUL SOLMAN: And White’s data suggests that the $3.5 trillion in outstanding commercial real estate debt could be what some fear: the other shoe about to drop.

ROBERT WHITE: We’ve tracked, at this point, $135 billion of commercial mortgages in the U.S. that we know are in default or in bankruptcy. Certainly, there’s probably more that we don’t even know about and many that are on the cusp. That number is growing by about $5 billion a month. It hasn’t slowed.

There have been estimates of $800 billion to $1 trillion of commercial mortgage defaults over the next several years, if we don’t find a solution to our current troubles.

PAUL SOLMAN: So then are gloomsters right in thinking a new default crisis is inevitable?

ROBERT WHITE: Many of the banks have been very willing to extend loans and delay the problem. And hopefully, by extending, the market will rebound before they actually have to realize those losses.

PAUL SOLMAN: Hopefully. But the latest surprising rise in unemployment bodes ill for both consumer spending and business investment going forward and, thus, you can see why the commercial real estate market could be another harbinger of continued tough times.