The next big crash?: Commercial real estate market faces wave of defaults

The Carson City commercial real estate market, like much of the nation's, is facing the possibility of a spike in defaults this year, say area Realtors.

Commercial real estate owners, including retailers, manufacturers and office building and apartment owners, who borrowed money during the peak of the market around 2005 are now facing the balloon payments on those loans.

But given the decline in property values and business, many are finding it harder to pay their lenders, increasing the likelihood of default or worse unless they are able to renegotiate.

"With the economy being as tough as it is, many retailers have walked away from their spaces," said Bruce Robertson, a Realtor with Sperry Van Ness in Carson City. "So now these properties are not performing at the same level underwritten for when the loans were made."

Last summer, the local vacancy rate was about 19 percent, according to a study conducted by Coldwell Banker Premiere in Carson City. Today, it is probably closer to 25 percent, and could reach as high as 30 percent this year, said Brad Bonkowski, a Realtor with Coldwell who co-authored the study.

"I think what we're seeing, people have been trying to hold on for the past three years as rents dropped and vacancies increased," Bonkowski said. "What we've seen in other parts of the country, when market rents fall to a certain point, and the property owner knows they're going to be out of compliance on their loan, they just walk away."

A prospective tenant in Carson City in 2007 may have had two or three properties to look at; today there's usually more than 40. The buyer's advantage puts more downward pressure on the market, Bonkowski said.

This trend has led to more private investors entering the local market, providing "bridge loans" to businesses. Some lenders are opting to "pretend and extend" on existing loans, a recent addition to the commercial real estate lexicon that means a lender keeps a distressed loan despite losing money on it, assuming it would be more expensive to maintain a vacant property in a down market, said Andy Tourin, the director of commercial services for First Centennial Title Company of Nevada.

Community banks are also the most heavily invested in commercial real estate.

"Community banks that have gone away has mostly been due to the fact that their portfolio in commercial real estate loans was non-performing," Tourin said.

Last week, Elizabeth Warren, chair of the Troubled Asset Relief Program oversight panel, told CNBC that by the end of the year, about half of all commercial real estate loans are expected to be upside-down, adding there are "2,988 banks, mostly midsized, that have these dangerous concentrations in commercial real estate lending."

As a February congressional report on the commercial real estate market noted:

"The loans most likely to fail were made at the height of the real estate bubble when commercial real estate values had been driven above sustainable levels and loans; many were made carelessly in a rush for profit.

"Other loans were potentially sound when made but the severe recession has translated into fewer retail customers, less frequent vacations, decreased demand for office space, and a weaker apartment market, all increasing the likelihood of default on commercial real estate loans."

Jack Prescott, the commercial real estate manager for First Independent Bank of Nevada in Reno, said he does not think the downturn in the commercial real estate market will be as dramatic as some are saying and that the bottom is likely close. He also adds there are still many businesses struggling to refinance.

"As bankers we would love to help every single borrower out there," Prescott said. "We are restricted at times due to the accounting rules and being able to still comply with regulations."

Stan Wilmoth, president of Reno-based Heritage Bank, said while there are landlords lowering rents, which is causing property values to fall, there are opportunities for potential buyers.

"We can all sit around and lament about them going down," Wilmoth said. "There's a lot of money sitting in the sidelines that is looking for a home."

And given lower costs, eventually the inventory of unused commercial property in the region will eventually be purchased - it just might take awhile.

"I believe it's an opportunity we haven't seen for a very long time," he said.