James Quinn submits:
There is a Part 2 to the story of
that will play out over the next decade. Consumers will deleverage
because they must. They have no choice. Boomers have come to the
shocking realization that you can't get wealthy or retire by
borrowing and spending. As consumers buy $500 billion less stuff
per year, retailers across the land will suffer. To give some
perspective on our consumer society, here are a few facts:
- There are 105,000 shopping centers in the U.S. In comparison,
all of Europe has only 5,700 shopping centers.
- There are 1.2 million retail establishments in the U.S. per
the Census Bureau.
- There is 14.2 BILLION square feet of retail space in the U.S.
This is 46 square feet per person in the U.S., compared to 2
square feet per capita in India, 1.5 square feet per capita in
Mexico, 23 square feet per capita in the United Kingdom, 13
square feet per capita in Canada, and 6.5 square feet per capita
Despite the ongoing recession and the fact that consumers must
reduce their spending over the next decade, irrationally exuberant
retail CEOs continue their death march of store openings. Below are
announced expansion plans for some major retailers:
- GameStop (
) - 400 new stores
- Walgreens (
) - 350 new stores
- Dollar General (
) - 315 new stores
- Ashley Furniture - 300 new stores
- Target (
) - 128 new stores
- Starbucks (
) - 100 new stores
- Best Buy (
) - 55 new stores
- Kohl's (
) - 50 new stores
- Lowe's (
) - 45 new stores
Retailers expanding into an oversaturated retail market in the
midst of a Depression, when anyone without rose colored glasses can
see that Americans must dramatically cut back, are committing a
fatal mistake. The hubris of these CEOs will lead to the
destruction of their companies and the loss of millions of jobs.
They will receive their fat bonuses and stock options right up
until the day they are shown the door.
All of the happy talk from the Wall Street Journal, CNBC and the
other mainstream media about commercial real estate bottoming out
is a load of bull. It seems these highly paid "financial
journalists" are incapable of doing anything but parroting each
other and looking in the rearview mirror. Sound analysis requires
you to look at the facts, make reasonable assumptions about the
future and report the likely outcome. Based on this criteria, there
is absolutely no chance that commercial real estate has bottomed.
There are years of pain, writeoffs and bankruptcies to go.
Let's look at some facts about the commercial real estate market
and then assess the future:
- The value of all commercial real estate in the U.S. was
approximately $6 trillion in 2007 (book value, not market
- There is approximately $3.5 trillion of debt financing these
- Approximately $1.4 trillion of this debt comes due between
now and 2014.
- The delinquency rate for all commercial backed securities
exceeded 9% for the 1st time in history last month and has more
than doubled in the last 12 months.
- Non-performing loans are close to 16%, up from below 1% in
Do these facts lead you to believe that the commercial real
estate sector has bottomed, as stated in the Wall Street Journal?
The Federal Reserve realized the danger of a commercial real estate
collapse to the banking system over a year ago. They have
encouraged banks to extend and pretend. The website
describes in detail what has occurred:
What has happened is the Fed has allowed this shadow
monetization of the debt and banks let borrowers roll over CRE
debt without even making payments in many cases! Think of an
empty shopping mall. There is no buyer for this in the current
market. So why would a bank want to foreclose on the borrower?
Instead, they pretend the asset is worth $10 million while the
borrower makes no payment and the Fed keeps funneling money
into the banking system. In the end, the value of the dollar
gets crushed and you end up bailing out the banking system.
Commercial real estate has collapsed even harder than
residential real estate. This market is enormous in terms of
actual debt. There is no official bailout on the books but it
is occurring through a slow and deliberate process. Banks know
that they are essentially insolvent and they are dumping this
junk onto the taxpayer.
This grim story began between 2004 and 2007. The horrifying
ending will be written between 2011 and 2014. Commercial real
estate loans for office buildings, malls, apartment buildings and
hotels usually have 5 to 7 year terms. If you thought the debt
induced bubble in real estate only affected residential real
estate, you are badly mistaken. Before the boom, a normal year
would see $100 billion in commercial real estate transactions.
Between 2004 and 2007 there were $1.4 trillion of deals done, with
2007 reaching a peak of $522 billion of commercial real estate
deals. Shockingly, the Wall Street banks, run by MBA geniuses,
loaned developers a half trillion dollars at the very peak in the
market. Sounds familiar. Thank God the taxpayer has bailed these
Einsteins out so they could live to make more bad loans and collect
big fat bonuses.
Commercial real estate prices rose 90% between 2001 and 2007,
driven by the loose monetary policies of the Fed and complete lack
of risk management on the part of the banks making the loans.
Knuckle dragging developers built malls, apartments, offices and
hotels with abandon as billions of dollars rained down on them from
Wall Street. The consumer delusion of debt financed wealth led to
the developer delusion that 100% occupancy and increasing rents for
all eternity were guaranteed.
Commercial real estate prices have dropped 42% in just over a
year. This means that the $6 trillion value of all the commercial
real estate in the country has dropped to $3.5 trillion. The debt
remained in place. The billions in debt issued in 2003 - 2005 is
coming due between 2010 and 2012. The underlying assets are worth
billions less than the debt that must be refinanced. Commercial
loan payments by owners can only be made from cash flow generated
by rental income. A key requirement in generating rental income is
Let's examine the current state of vacancy rates for offices,
shopping malls and rental properties. The current office vacancy
rate of 17.5% is the highest since 1993 and is just below the
all-time high 18.7% in 1992. The WSJ has concluded, with no data or
analysis, that the vacancy rate has bottomed. As the employment
data proves, companies are not hiring employees. New companies are
not being formed. Government mandates and regulations regarding
healthcare and uncertainty about taxes will keep the formation of
new small companies at a minimum. Conglomerates continue to ship
jobs overseas. Part 2 of this Depression will drive more companies
out of business. Office vacancies will remain at record levels for
the next five years.
Mall vacancies between 9% and 11% are at record levels. There is
absolutely no chance that these vacancy rates decline over the next
few years. With consumers deleveraging, wages stagnant,
unemployment high, and retail oversaturation, there are thousands
of retail stores destined to close up shop. Ghost malls are in our
future. They will come in handy as homeless shelters and soup
kitchens. Mall developers will be defaulting in record numbers.
Apartment vacancy rates peaked at 11% in 2009, the highest level
in history. With millions of vacant homes and millions of available
rental units, rental rates will stay low for years. The cashflow of
apartment developers will be under stress and will lead to more
Based upon the current rising delinquency rates of 15.7% for
commercial real estate loans and 9.05% for CMBS, there is no bottom
in sight. Only raging mindless optimists like Larry Kudlow could
ignore the facts and conclude that all is well in the commercial
real estate world. Banks pretending that the loans on their books
aren't worth 40% to 50% less, while also pretending that borrowers
with negative cash flow can make loan payments, is not a solution.
It is a Federal Reserve encouraged fraud. Allowing loans to be
rolled over with no hope of ever being repaid will only prolong the
pain and delay the inevitable.
The facts are that hundreds of billions in commercial loans are
coming due, with a peak not being reached until 2013. If banks were
to properly account for the true value of these loans, hundreds of
regional banks would be forced to fail. This is unacceptable to
government authorities. They will insist that the fantasy continue.
Banks and real estate developers will pretend to be solvent, hoping
the economy will miraculously repair itself and eventually make
them whole. I understand these bank CEOs and delusional developers
also believe in Santa Claus, the Easter Bunny, and the Efficient
Market theory. It seems our entire financial system is based upon
debt, fantasy, fraud, and delusion.
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