Distressed Real Estate Continues to Grow

Ever since the start of the residential housing crisis, the commercial real estate industry has been waiting for the other shoe to drop: that is, for the defaults to hit their sector. It appears that moment is at hand. According to the Distressed Asset Recovery Team, a new consultancy that moment is at hand.

The group reports that the total value of distressed commercial real estate in June 2009 was $97.4 billion--twice the $49 billion of March and four times that of December at $25.6 billion. Retail properties, not surprisingly, represent the largest segment in June, at $29.7 billion, boosted by General Growth Property's recent bankruptcy filing and retailing's sector malaise. Other asset classes, as well, also showed deterioration in fundamentals: even office properties, which recorded the smallest increase, was up 33% to $15.3 billion.

Much of this is playing out on a location by location basis. The report finds that the Manhattan market has the highest volume of distressed real estate assets, followed by Los Angeles-Orange County. Miami, with $482 in distressed commercial property per capita, has the highest ratio per capita. It is estimated that the DC area will see $4 billion in commercial real estate defaults by the end of the year, primarily by developers that were unable to refinance.

With implications for commercial real estate portfolios, the impact is showing up in state budgets.

In preparing the federal budget proposal for the upcoming fiscal year, the White House and the Office of Management and Budget (OMB) made a number of assumptions regarding the economy's direction. In almost every respect, those assumptions have been proven to be overly optimistic.

Amongst the miss called projections:

• national unemployment rate 130 basis points above the OMB's expectation for the year;
• the federal government's fiscal year-to-date receipts are down 18.0% as compared to the same time last year;
• corporate tax revenue down 23.0% as compared to the same period last year;
• corporate income taxes are down 61.1%;
• The year-to-date deficit of $992.0 billion is more than three times last year's deficit through May of $319.4 billion;
• The pace of the federal government's public borrowing has increased five-fold since the beginning of the current fiscal year.

At the state level, however, the challenge of declining revenues must be met with cutbacks in spending or increases in tax rates; immediate recourse to deficit financing is not an option. As a result, states across the country now face difficult budgetary choices leading into the new fiscal year.