The Commercial Real Estate Shoe Has Dropped

There is a terrific article in The Contra Costa Times: Real estate woes not solely residential

A vast auto dealership is empty in Oakland, visible from the freeway. In Pittsburg, a big housing development looms over a downtown street, unfinished and vacant. Hotels in Brentwood and Oakland are isolated behind cyclone fences. A mammoth residential development is idle next to the Caldecott Tunnel.

These troubled projects all are mute testimony to a financial malaise that first sickened the housing market and has now infected a broader part of the wheezing regional economy.

During a half-year period stretching from October through the end of March, mortgages totaling $784 million have slumped into default for dozens of commercial or development properties, including some huge residential subdivisions, in the East Bay.

"The commercial real estate shoe has dropped, and it is sitting on the ground crying," said Christopher Thornberg, partner and economist with Beacon Economics. "This is a huge problem."

This new downturn is also a significant challenge for the economy generally. Undeveloped or partially built projects stalled by foreclosures or bankruptcy can weaken economic growth in a community. Existing projects that are in default can fail to attract retailers or new businesses to a city. Buildings that are delayed in getting off the ground because of financial woes portend fewer construction jobs.

Bottom line: The recession that began with sales of individual houses, then spread to banks, retailers and automakers, now has commercial real estate in its grip. This relapse for the economy has arrived just when the fallen residential sector has begun to stagger off the ground.

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An array of East Bay projects are involved. Retail, office, hotel, mixed-use and land projects and other kinds of commercial or development sites went into default during that half-year period.

Oakland, Fremont, Concord, Walnut Creek, Brentwood, Hayward, Pittsburg, Livermore, San Ramon, San Leandro, Richmond, El Cerrito, Martinez, El Sobrante, Orinda, Bay Point, Bethel Island, Clayton, Castro Valley, and Union City were hit by these delinquencies.

Some are high-profile:

Southland Mall in Hayward couldn't pay off an $81 million mortgage that matured and its owner has declared bankruptcy.

The 1,600-acre Wilder development, a huge subdivision of luxury homes and public uses in Orinda, is in a $180 million default.

Delta Coves, a Bethel Island project expected to be a new Discovery Bay, is stalled by a $55 million default.

Multiple residential-retail mixed-use developments languish in downtown Oakland, hit by defaults totaling $140 million.

Part of the Park N Shop center in Concord was hit by a $12.8 million default.

The Sheraton Pleasanton Hotel suffered a $12.2 million default.

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Retail and office buildings could be hit the hardest.

"You have a lot of concerns with retail because of the shopping centers that were put up in places like east Contra Costa and San Joaquin County," said William Nork, a senior vice president with Cornish & Carey, a commercial real estate company.

"With office buildings, you see more vacancies and falling rents," Nork said.The worsening woes for commercial property can adversely affect communities that were expecting completion of a key development.

My Thoughts: It makes perfect sense…during the boom, office and retail space were overbuilt. Now that the economy is pushing the marginal tenants out of business, vacancy is skyrocketing and rents are collapsing. I recently read about the construction of the Twin Towers in New York City. Hundreds of thousands of un-needed square feet of commercial rental space were thrust on the market, depressing rents and property values for a decade.

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The commercial development woes could imperil already shaky banks, warned Michael Yoshikami, president of Walnut Creek-based YCMNET Advisors, an investment firm.

"We are just beginning to see the impact of the problem on bank balance sheets because of commercial property delinquencies," Yoshikami said. "Banks will face rising commercial defaults."

The solvency of some banks may be jeopardized by commercial failures.

"It is going to be a mess for bank balance sheets," Thornberg said.

Numerous commercial mortgages will mature in 2010, 2011, and 2012, which presents new problems, said Hans Lapping, an attorney and shareholder with the Walnut Creek office of law firm Miller Starr Regalia.

"No one anticipated the credit market would collapse," Lapping said. "You have a tremendous amount of debt that people will not be able to refinance."

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Yet the commercial property slump can benefit companies that hunger for lower rents. Opportunities may emerge for investors, said Bruce Ring, a principal with law firm Morgan Miller Blair and an attorney with the Walnut Creek realty practice.

"A lot of money that was lined up to buy residential is starting to look at income-producing commercial properties," Ring said. "They are looking at apartment buildings and retail properties with creditworthy tenants."

My Thoughts: If this is the beginning of the commercial real estate downturn, it would certainly seem premature for investors to be buying…especially if rents are trending downward.