Growing bubble in commercial real estate

From The Street:

No Shortage of Bubbles and Troubles
By Jim Jubak

But I think it’s premature to slap the Fed on the back and say “mission accomplished.” The truth is the Federal Reserve still hasn’t pricked the financial bubble that it created with nearly a decade of easy-money policies.

Oh, the housing market bubble may be deflating, with or without the abrupt pop that ended the stock market bubble of 2000. But the Fed hasn’t succeeded in sopping up the flood of cheap money it created when it drove short-term interest rates down to 1% in June 2003 and kept them at that level until June 2004. Now all of that cheap money is pushing up borrowing in the commercial real estate market fast enough to worry bank and savings and loan regulators. And that isn’t the only sector in the midst of a bubble.

It might be better to name this the “Lady Macbeth economy.” Cast Fed Chairman Ben Bernanke as Shakespeare’s bloody queen who cried, “Out, out damn spot,” as she vainly tried to wash the blood of a murdered king from her hands. In this economic version of the tragedy, however, Bernanke wanders the darkened halls of the Fed muttering, “Out, out damn bubble,” as he tries to wash away the financial curse left to him by his predecessor, Alan Greenspan.

Take a look at what regulators fear is a growing bubble in commercial real estate. On the national level, commercial real estate loans climbed to $1.3 trillion in 2005, up 16% on the year. The Office of the Comptroller of the Currency has found that a third of nationally chartered banks have commercial real estate loans that amount to 300% or more of bank capital.

The Office of the Comptroller has said that banks with more than 100% of their capital in construction loans or more than 300% of that capital in commercial real estate generally need more thorough scrutiny from regulators.

On the local level, commercial real estate lending has taken up the slack left by a slowing residential mortgage market. In Florida’s Manatee, Sarasota and Charlotte counties, 21 local community banks increased their real estate lending by 40% in the 12 months that ended in June 2006 from the prior 12-month period, according to the Federal Deposit Insurance Corp. — even though residential real estate sales are down about 40% in the area in 2006. The biggest increase — some 74% — came in commercial construction and development loans.

Until the underlying excess liquidity is removed from the system, deflating one bubble will just produce another bubble somewhere else. So far, the world’s central banks and sovereign governments have shown little ability — and in many cases, no real inclination — to slow the growth in the supply of global capital, let alone actually reduce it.

So the Federal Reserve is left with a dangerous brew like that boiled up by the witches at the beginning of “Macbeth.” Remember what they chant: “Double, double, toil and trouble/Fire burn and cauldron bubble.”

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3 Responses to Growing bubble in commercial real estate

  1. James Bednar says:

    From Reuters via Fox.

    Mortgage Applications Dip in Spite of Falling Rates

    U.S. mortgage applications fell for the first time in four weeks even as interest rates dropped to a six-month low, an industry trade group said on Wednesday, providing further evidence the country’s housing market slump is deepening.

  2. Sapiens says:

    This dog wont hunt. Business doesn’t need to warehouse large number of workers in expensive real estate.

    With the advent to telecom, you can have all processing done in cheap labor/real estate locations.

    Witness all the for sale and lease signs in office space.


  3. Andrew Gowdy says:

    There is a possibility that the commercial lending business could face the next bubble. We just have to take what we learned from the residential market. If you had a pulse and at least a 500 FICO score, you could get a mortgage.

    This increased the potential buyers in what was then a “Seller’s Market.” And the bidding wars began.

    Many lenders will have to tighten their already stringent requirements to reduce the risk of loss. Also, lenders will have to invest in diverse types (“buckets”) of commercial real estate to spread the risk.

    Because the federal regulators are watching the activity of many commercial lenders, many potential investors/business owners that have unusual situations (can’t show income or low loan amounts)will be unable to get funding. This will open up the opportunity for private investors to fill the gap.

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