Foreclosure fear spreads across commercial market

Five years ago, midstate lenders doled out commercial mortgages the same way they did residential loans, betting with property owners that occupancy and rental rates would continue to grow.

But those rates didn't grow; the economy instead fell apart. Now lenders worry borrowers who waged millions of dollars on commercial projects could find themselves not able to pay off mortgages that come due next year.

It could create a crisis in the national commercial market similar to the one that flooded the U.S. housing market and hit home in Central Pennsylvania over the past two years.

"There is a tremendous amount of fear," James Koury, partner at RSR Realtors based in Lemoyne. "Lending was based on the fact that occupancy would go up and rental rates would go up. Short sales are happening all over the place residentially. It's going to be the same thing on the commercial front."

Commercial mortgage terms vary, but generally, commercial property owners have five to 10 years to pay off mortgages or refinance them.  And there was a major uptick in the amount of commercial mortgage backed securities issued in 2005 compared to 2004, according to the national Mortgage Bankers Association.  Commercial mortgage backed securities are bonds made up by several commercial mortgages. Often, large industrial and shopping center mortgages are sold into bonds.

In 2004, $93 billion  in commercially mortgage backed securities were issued in the U.S. There was $164 billion  originated in 2005, according to the association.

Some brokers and other commercial real estate professionals say next year will only be the cusp of the commercial foreclosure crisis and that 2011 and 2012 will be even worse nationally. In 2006, $202 billion in commercial mortgages backed securities were originated, and in 2007, $231 billion was issued, according to the association.

When it comes to foreclosures, however, it's all a matter of degrees, brokers said. And brokers said that while the midstate will be affected by the commercial foreclosure crisis, it will not be as bad here as it is in other parts of the country. It will resemble the housing foreclosure scene that developed in the midstate over the past several years.

For example, compared to places such as Phoenix and Miami, where housing ballooned several years ago, the midstate has been somewhat shielded from the residential foreclosure wave that swept the U.S. Local lenders did not jump on the subprime lending bandwagon that other national lenders drew up to help get more people into houses, which was a major driver of the residential foreclosure crisis.

There were 4,030  housing foreclosures in the midstate this year through October, excluding Lebanon County, according to Realty Trac, a real estate Web site that monitors and lists foreclosures, pre-foreclosures, auctions, new construction and other properties. Realty Trac did not list a Lebanon County year-to-date foreclosure count on its Web site. To give it some perspective, in Phoenix, there were 27,832 houses foreclosed on this year through October, according to Realty Trac. In Miami there were 28,525 foreclosures. 

Many regional businesses that mortgaged commercial properties took mortgages out with local banks, too, which did not draw up exotic loans or sell them on the securities market, brokers said.

And banks will be more willing to restructure mortgages, said Jay H. Bryson,  global economist for Wells Fargo Securities, which is part of Wells Fargo & Co. based in San Francisco.  Banks are not in the real estate business, Bryson said. And if they don't renegotiate terms, they will be stuck with properties with lower property values that are not performing well, he said.

If banks happen to not renegotiate loans, property owners now are going to have a hard time finding other investors in this economy to help pay down the debt, Koury said. 

Last year, only about $10 billion in commercial mortgage-backed securities were originated through the first two quarters, according to the Mortgage Bankers Association. The association did not list the amounts originated during the second two quarters.

Lenders lent to a slew of commercial customers five years ago because the economy was much stronger, but occupancy rates are down or projects never got built as the financial markets crashed, brokers said. That is why much of the fear exists, Koury said.

In Central Pennsylvania, property owners who own empty parcels could get hit hardest next year, he said. Five years ago, the midstate got on the commercial map when national housing developers, including Toll Brothers Inc., and Lennar Corp.,  arrived and started buying properties, he said. That made property values skyrocket, and a lending frenzy took place with national and local developers, Koury said.

Then the economy sank, and the national developers left as quickly as they came. But there are still a lot of local property owners out there, many of which never got to develop their projects, he said.

Owners will not be able to sell properties for the prices they paid for them, Koury said. Investors might only get $1 million for a property they paid $2 million for five years ago, he said. Property owners without buildings on their tracts have a harder time paying off their mortgages, too, because they have no income generated on the property, he said.

Dan Alderman, a broker at Wormleysburg-based commercial real estate group NAI CIR has a brighter outlook. Small to medium-sized property owners need not worry next year, Alderman said. The larger industrial properties and shopping center properties will go into foreclosure before small to midsize office buildings go down in the midstate, he said.

Alderman said he has seen a lot of activity selling and leasing small to midsize commercial properties. Companies that developed their third or fourth shopping centers as the economy fell are the ones that are going to get hit hardest in the midstate, Alderman said.

The Harrisburg Mall is an example of what could happen to larger properties next year if mortgages are not paid off or refinanced, Alderman said. After taking on a large, two-phase redevelopment project, the owners of the mall suffered from lower occupancies as the economy sank. The former New York-based owners of the shopping center defaulted on their mortgage, and the bank put the mall up for sheriff's sale last summer.

The property owners who have pieced together commercially backed mortgages with various entities are the ones that will be in trouble, he said. 

 "Harrisburg Mall went into bankruptcy because they couldn't refinance their mortgage," Alderman said. "It's the places that have two to three of their (big) tenants gone. Cash flow is king in investments."

Banks will be more willing to work with borrowers that have continued to make their mortgage payments and those that have better occupancy numbers, Koury said. But a lot of properties are not generating income, he said, and that is where the problem lies.

"Properties are not generating cash flow. Borrowers are having a tough time making principal and interest payments. It resorts back to the economy," Koury said. "When you take a look at an office building, three years ago you had an office building occupied and generating income and the bank would lend money on it. Now the bank is saying, ‘this asset is not worth the same amount of money.' It's going to hit (Central Pennsylvania) more on the raw dirt," Koury said.