World - US heads into another real estate mess

NEW YORK: Walk the streets of midtown Manhattan, listen to the jackhammers, look at the cranes on so many blocks and you might conclude: these people are in the midst

US mortgage crisis: A subprimer
of a big commercial real estate boom.

You might be right, but not for long.

Non-residential property investment in the United States, which usually tracks economic growth with a delay, has stayed unusually strong unusually long into what is looking like an increasingly ugly and protracted recession.

And that is pretty bad news, both for the economy and the banks. The economy is about to suffer the latest dropping of other shoes when non-residential construction, which includes everything from hotels to office buildings to manufacturing plants, turns sharply south and removes one of its few supports.


There simply won't be enough demand for all of these new office buildings, malls and hotels, even in places that aren't banking centres. And manufacturing and power construction, which have been very strong, may be hit by dropping demand, both at home and overseas, as a global downturn takes hold.

Development will slow or contract, jobs will be lost and economic activity diminish.

And the banks themselves, which are already such basket cases they require government support, are about to see the value of the commercial real estate loans they own get whacked, prompting yet another self-reinforcing cycle of loan writedowns, tightening credit and loss of confidence. "It takes a lot of time until projects are finished and there were a lot of things in the pipeline. But developers are probably not very happy about it," said Harm Bandholz, an economist at Unicredit in New York.

Because it takes time to plan, finance and build a building, it is not unusual for development to carry on after gross domestic product growth begins to weaken, but this time it has defied gravity. "Usually you have a tight correlation between GDP and construction, with a lag of two quarters. This is unprecedented," he said.

Private investment in structures grew by 14.3 per cent in the second quarter as compared with the quarter before and though it is a fairly small sector actually contributed almost a half a percentage point to GDP growth.

The growth was concentrated in the manufacturing, power, lodging and office sectors, all of which face considerable headwinds now. Manufacturing is sensitive to domestic and global growth, which is falling. Power plants may be less profitable with oil now in double rather than triple digits. Hotels would seem to be a natural to lose out during a recession, and offices need businesses and workers, of which there will be fewer.

BANKS LENDETH, BANKS TAKETH AWAY


The question arises as to how and why the banks were actually lending to finance all of this construction. The Federal Reserve Senior Loan Officer survey shows that banks have tightened up on terms and availability sharply. Loans for commercial real estate are now as hard to get as they have been since at least the early 1990s.

That too indicates a sharp drop off in new activity, and yet another negative for economic growth.

But what will a downturn do to banks? It certainly won't help. While delinquencies in commercial real estate loans are up and banks have moved to write down more of their exposure, levels are still way below those typically seen in a large recession.

Delinquency rates were 4.24 per cent on commercial real estate loans in the second quarter, according to Federal Reserve data, up quite a bit but nowhere near the double digit rates in the early 1990s. Charge off rates, the level of loans that banks write down as losses, were a bit less than 1 per cent in the second quarter, less than half the peaks of the early 1990s.

Christopher Whalen, managing director at Institutional Risk Analytics, a firm that specialises in financial and banking analysis, said he sees writedowns of commercial real estate loans hitting double their early 1990s seasonally adjusted peak, or about 4.5 per cent. A quadrupling on writedowns from here would have a big impact on capitalisation for an industry that is already bleeding and having grave difficulties attracting new free market investors.

"If the hole we have dug is as big as we think in the United States, what does that do for loss rates at bank?" said Whalen. "You will see a situation where you have a lot more developers filing for bankruptcies." He also thinks this, in conjunction with soaring rates of loss on other loans, could push more large banks into the arms of the US government.

So, timed as it is the coming commercial real estate bust will reinforce the credit crunch, put further strains on taxpayers and deepen a recession that already threatens to be one of the worst in decades.

Manhattan, and the United States, will be a lot quieter in six months' time. We may come to miss the sound of hammering.