Why Bailing Out Commercial Real Estate Is a Bad Idea

Downturns in commercial real estate are part of the life cycle of the economy. Developers build up, thinks are hunkey-dorey for a few years, then vacancies start falling, refinancings get harder and there’s a crash. After a clean-out, the cycle starts again.

So why is it suddenly so urgent that commercial real estate sign on to the continuous federal bailout program that has so far recapitalized banks, extended credit and and given a bridge loan to General Motors and Chrysler?

Good question and hard to answer.

The industry version is that, as is typical of the commercial real estate cycle, some $530 billion in commecial mortgages will come up for refinancing in the next few years with $160 billion due this coming year. Given the credit crunch,  refinancings are harder to do. This started in the summer of 2007 when the credit crisis took hold and since then refinancings have dropped by two thirds.

So, a slew of commercial mortgage companies and trade groups are petitioning to be included in the new initiative for a $200 billion bailout to subsidize credit card, student loan and car loan debt. The idea is for money to go to help finance purchases of securities backed by these commercial real estate asets.

What happens if the bailout doesn’t happen? The U.S. faces another threat to the global financial system, bailout proponents claim. In other words, it’s the same “TBTF” (”Too Big to Fail”) logic that has given firms such as AIG upwards of $150 billion in bailout money.

There are some problems with the logic:

• Blogger Douglas A. McIntyre writes on 24/7 Wall Street: “If almost every industry needs $100 billion or more and another $600 billion will go to create new three million jobs (the propsoed Obama stimulus), the rescue of the U.S. economy is going to hit $2 trillion or $3 trillion.”
• Felix Salmon states on Portfolio’s Market Movers: “So if I were Barack Obama, I’d be pushing my economic team right now to come up with some clearly-defined principles for bailout finds: what they’re for, how they should be used, where they should be spent, where they should not be spent.”
• Robert Brunswick, president and CEO of Buchanan Street Partners:  “Ultimately market forces not unduly influenced by an outsized participant are a better mechanism for valuing these assets. If the government overpaid for these securities –a real risk given its size in the market and its public policy mandate — comparable assets could end up trading at overvealued prices. This would have the effect of extending and incrementalizing the realization of these mark-to-market losses or delaying their trading because sellers would wait to get the ‘government price.’”

I can think of another reason to view the bailout with skepticism. Much of the real estate involved is in suburban and exburban sprawl zones where bad planning has been a big problem. Too many commercial developers build car-centric, “Big Box” stores only to vacate them to build others a few miles away. A hiatus in this type of development would be a good thing for the country because it would give time for localities to catch up with such destructive growth and provide needed services.

However, the ultimate question is: “where will the bailouts end?”