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VOL. 125 | NO. 37 | Wednesday, February 24, 2010

Commercial Real Estate Raises Red Flags for Bankers

By Andy Meek

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The Exchange Building, 9 N. Second St., right, fell into foreclosure this month.  At left is the Goodwyn Condominiums, which also recently foreclosed. Photo: Lance Murphey

This month’s foreclosure of the 19-story Exchange Building apartment tower at 130 Madison Ave. is a local example of a problem that’s sounding alarm bells in the banking industry.

It’s the commercial real estate version of the mortgage meltdown that clobbered the housing industry. Signs are emerging that it’s poised to pounce on banks, the real estate industry and policymakers who have spent the past two years working to quell that previous crisis.

But there’s a big difference between foreclosures of a few $150,000 homes and a few offices, hotels and shopping centers that have much steeper price tags.

Waiting for the shoe to drop

Belly-ups of those pricier properties also magnify the pain for whoever holds the debt. Dire warnings from some corners of the financial industry are predicting a wave of small bank failures as more than $1 trillion of commercial real estate debt matures in the coming years.

Community banks tend to have deeper exposure to commercial real estate (CRE) loans. Many of them hold on to those loans rather than selling them to investors.

Last week’s Exchange Building foreclosure came at a moment when scrutiny of the problem is intensifying. The Exchange Building Limited Partnership defaulted on a $2.9 million construction loan through First Tennessee Bank NA dated January 31, 1995.

During a presentation last week, Independent Bank co-chairwoman Susan Stephenson called CRE problems the “proverbial other shoe” that will bring a new round of financial pain once it drops.

The Exchange Building, 9 N. Second St., fell into foreclosure this month. Photo: Lance Murphey

She said she expects many more banks to join the 20 that already have gone bust in 2010. She pointed to commercial real estate as cause for concern.

“If you consider the overall economics of the CRE market, I don’t see how we can’t have some negative impact in the sector going forward,” said Bank of Bartlett chief financial officer Dale Stover. “The holders of the debt are going to have to renew the loans that support that debt, and when they do, they are likely going to see some deterioration in value.”

That’s one of several key points in a report issued a little more than a week ago by the watchdog panel Congress formed to monitor the government’s bailout programs.

More than $1.4 trillion of CRE loans will mature by 2014, according to the report. But half of those loans are greater than the value of the underlying property.

“Even borrowers who own profitable properties may be unable to refinance their loans as they face tightened

underwriting standards, increased demands for additional investment by borrowers and restricted credit,” reads the report from the Congressional Oversight Panel.

Artificial signs of life

Mark Dotzour, chief economist and director of research for the Real Estate Center at Texas A&M University, painted a CRE market clouded by uncertainty during last week’s Commercial Property Forecast Summit.

During the Memphis Area Association of Realtors Commercial Council-sponsored event, he said the way the economic rebound unfolds – particularly where jobs are concerned – is linked to how the CRE question gets resolved.

He compared commercial real estate to a military vehicle rumbling across unfamiliar and unfriendly terrain. The uncertainty about its future is one of “several land mines that have to be cleared,” he said in his presentation.

Shelby County’s commercial real estate activity market in January showed signs of a slightly quickening pulse. The county registered 57 commercial sales last month, up 8 percent from January 2009’s 53 sales, according to real estate information company Chandler Reports, www.chandlerreports.com.

The total dollar volume was up 55 percent from the previous January.

But don’t tell that to the 27 owners of a loan that financed the office complex at 1023 Cherry Road. The Wall Street Journal earlier this month profiled the collapse of that venture – which went into foreclosure in the fall – as another example of investors getting burned on a CRE deal.

Investors in the deal lost anywhere from $100,000 to $700,000 each, according to the story. Its headline: “Small Investors Lost it All in Memphis.”

“If you look at the areas that were overbuilt in the residential real estate market, you will also see overbuilt CRE,” Stover said. “If people aren’t buying the houses, then there are no people to support the businesses. So how can we not see some negative impact?

“And I think the potential is there for significant impact at some institutions.”

Chandler Reports is a division of The Daily News Publishing Co. Inc.

PROPERTY SALES 73 147 18,012
MORTGAGES 89 184 20,749
BUILDING PERMITS 117 258 37,094
BANKRUPTCIES 55 114 11,540