Commercial real estate problems looming?

We haven’t paid enough attention to commercial real estate concerns in this recession. Lately, though, we’ve been getting some feedback suggesting that we need to keep a closer eye.

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Douglas Mayo, a commercial real estate consultant and source in MPR’s Public Insight Network, got us thinking about this when he wrote us recently that foreclosures in commercial properties would be the next big trouble spot in the local market.

“It’s expected that during this year and next there will be increasing foreclosures on commercial properties, such as recently was the case with Northland Inn in Brooklyn Center and Pentagon Office Park in Edina,” Mayo wrote.

Most commercial properties are financed with five to ten year debt. Some of these were financed during the good times, during the past decade, so this debt is now coming due. With increasing vacancies and slow absorption, the value of these properties is decreasing.

Since lenders establish maximum loan amounts depending on the property’s value, owners now experience difficulties finding lenders willing to approve sufficient new debt to pay off existing loans.

At the same time the existing lenders want to get these loans off their books, since they’re a drag on their balance sheets.

Some lenders are willing to work with debtors to find creative solutions, such as refinancing existing debt with equity sharing, but in other cases the only alternative is default and subsequent foreclosure.

Minnesota Public Radio’s Dan Olson gave us an in-depth look last year at the commercial real estate market in the Twin Cities and the potential for a foreclosure storm.

With the residential market appearing to have hit bottom, I thought the worst was over for real estate. But after hearing from Mayo, I reached out to other commercial real estate pros in our Network and got back some similar responses. (Add your voice.)

“The looming commercial real estate debt ‘crisis’ is indeed slowly happening and will build as long as the economy doesn’t show real growth in the private sector,” said Jamie Wellik, a real estate consultant and blogger.

Unemployment will have to drop below 6 percent to absorb the idle space before vacant space starts to be leased up, he said. (Minnesota’s jobless rate is running just over seven percent.)

Because banks usually keep commercial loans in-house they have some latitude, some discretion, and some inability to walk away now that these 5 and 10 year commercial mortgages are coming due.

They knew if they call in the loans or ask clients to put more money down on a (refinance) it might not be workable, but banks have to try to cover these potential losses as best they can to improve their balance sheets.

Banks will evaluate the loans and make decisions, sometimes the tough decision is to take a loss on a loan and liquidate it to investors with cash-I’ve seen that for the past two years.

I know that investors under pressure from banks will try to sell some of their properties just to raise cash

We’ve already seen smaller banks fail around Minnesota because of their bad commercial loan portfolios, and in-town, many smaller commercial properties have been abandoned by owners (I just toured several in North Minneapolis…).

The key question, said Wellik, is whether that trends hits more medium sized and large properties — “especially properties in once-stable suburbs.”

I got several other responses, including one that was not as worried as Mayo and Wellik about the region’s commercial real estate problems. (I didn’t feature it here because the source would not let me use his name).

If you have some perspective on Minnesota’s commercial real estate market and its health, post some insights below or contact us directly and keep the conversation going.

Said Wellik: “It’s sad to walk into so many empty spaces — lots of hurt out there. I’ve been through several buildings (during May) where staff is reduced, shifts laid off, and half the place is empty. ”

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