Commercial Real Estate Catches A Break, Or Does It?

New guidelines recently issued by U.S. government agencies are directed at preserving the health and welfare of banks holding commercial property loans. The CRE market sector is in trouble with thousands of properties representing nearly a trillion dollars either in default, foreclosure or bankruptcy. The crisis represents a greater risk to the nation’s banking industry than the residential mortgage collapse.

The FDIC, Office of the Comptroller of the Currency and the Federal Reserve have intervened with new guidelines that ease the pressure on banks. Essentially, they relaxed the definition of “performing” loans so that properties experiencing problems with cash flow, equity, or extended delays in selling can still be counted in this category. That means they will not be counted in “non-performing” categories and thusly not affect bank ratios negatively and push holding institutions into failure.

It gives the lending institutions a chance to work with their Commercial Real Estate (CRE) debtors in a more problem-solving manner, encouraging extensions, work outs and the like.

Good news, right? Yes. Well, maybe.

It is true that banks catch a break on this one, but what is really happening here? Yes, it helps ease the immediate pressure and that is important not only to the banks, but to their commercial and individual investors and customers as well. Taking the pressure off this way means the government does not have to come up with another trillion dollar rescue program – at least not for now.

But it does have the sense of “extend and pretend” about it. The numbers aren’t changing at all. These new guidelines don’t make properties any more valuable or speed a recovery. They are more about avoiding or delaying a collapse.

There is an opportunity cost to the market, however. Large capital has been staging on the sidelines waiting for distressed properties to become available at bargain (some would say rational) prices. This move by the Fed and other agencies will keep many properties out of the sale arena. That means new capital will not enter the system and brokers, architects and contractors will remain on the sideline. There will be a direct effect on rising and extended unemployment rates in these labor sectors.

Allowing CRE to undergo the kind of failure that residential real estate experienced would be yet another catastrophic blow to the economy, especially to those invested in organizations holding large CRE liabilities. On the other hand, it would have allowed properties to be purchased at prices which enabled the revitalization of not only the properties themselves but also an important labor segment, which in turn would have had a positive affect on the economy at large.

The economic crisis we still endure is a very complicated matter. There are no easy choices. In this instance the government acted to support the financial system. Let’s hope it turns out to be a wise decision.