Scary Chart

This chart from scares me even more than the Annaly stock chart on the previous post.

Delinquencies in CMBS tracked by Trepp

As you may notice, the chart begins with April of 2009, roughly when the REIT index began its extraordinary run to the stratosphere.  At that time, commercial mortgages in CMBS (give or take about half the loans out there) were sporting a 2.45% delinquency rate.

Today, the IYR, an ETF that acts as a proxy for the Dow Jones Real Estate Index, is trading around $55, up from less than $35 a year ago.  Why the optimism?

Rents and occupancy are going down.  Delinquency and default is going up.

It is possible for commercial real estate to have negative value, since maintenance costs and taxes can exceed the rent you might collect.  Only the very worst situations in residential properties can take you there, and those are most likely to be situations with undeveloped land, condos (suffering from the same maladies as their rental apartment cousins), or situations with toxic mold or other huge repair costs.

The overhang in underwater commercial real estate loans on bank balance sheets is most likely (on a relative basis) worse than the overhang of residential real estate loans waiting in the queue to be foreclosed.

Recall that by April of 2009 we were, as a nation, already starting to see signs that the worst of the economic indicators were dropping less quickly, or possibly even turning positive.

Not so for commercial real estate, which runs on a longer “reset cycle.”

For example, with only a couple of percent of loans in delinquency, it was probably justifiable for banks to carry those l0ans at par value.  Not so now, since almost all those loans are “balloon” mortgages that need to be refinanced five or ten years after origination.

For sure the values used to finance commercial properties in 2005 don’t apply today.  Even the real estate values from 2000 may not hold up, since many sub-markets in America have experienced a drop in net income from then until now.

At least US residential mortgage loans today consist of self-amortizing 30 year loans that don’t have that horrible large principal payment at the end.  That may be the silver lining in residential mortgage land that has kept us from tipping into an unrecoverable deflationary spiral.

Not too many commentators have considered the fact that residential loans in the 1930’s were like the commercial loans today — they came due and payable in lump sums after three to five years.

As those loans came due, unless the borrowers could pony up huge additional principal payments, the families had no choice but to load their belongings into the Model A and hit the road.

I will allow that the commercial REIT sector did take advantage of the window of opportunity the 2009 stock rally gave them, and lots of them raised additional equity.  So maybe that’s why the real estate index stubbornly sits within spitting distance of where it traded in the summer of 2008.

Color me skeptical.

As painful as it is, I’ll hold my SRS and FAZ for a while longer.

My buddy Robin Landry (excellent technical trader) just sent me one of his occasional market comments.  I only get them a handful of times each year, and they’re worth paying attention to.

He says to watch 10,850 on the Dow.

While still allowing that we may have one more high in this large counter-trend rally ahead of us, Robin feels that a convincing breech to the downside will signal the beginning of a very meaningful correction, or even dreaded Elliot Wave III on the 20-year chart.  You don’t even want to know the target on the downside if that’s what is developing.


4 Responses to Scary Chart

  1. […] By the way, not to steal his thunder, but go look at the 30+ days delinquent mortage rate chart on Howard’s Tuesday posting. […]

  2. earnest rheault says:

    At some time we will have to bite the bullet and enjoy a series of hard times finincially speaking when is the only question, We as a nation cannot ever pay back Multi Trillions of paper funny money with tax receipts especially with only half of the workers paying income taxes and deadbeats geting tax refunds for not working, this should be very interesting.

  3. Stephen Swaim says:

    Great chart Howard. Here in the industrial midwest I am seeing exactly the scenario you point out, cash flows of “many” commercial properties going down towards the operating cost levels, in fact some are below the operating cost level! Of course there will always be some problem properties, but now I am seeing more and more in my everyday regular business which indicate to me in this geographic area at least there is an overall deteriorating commercial real estate environment.

    Up to a point the developer/owner/syndicator of commercial real estate can “Rob from Peter to Pay Paul” by deferring maintenance, dipping into reserves, or engaging in some sort of bookkeeping sleight of hand, but eventually it all comes down to CASH and CASH FLOW. Reduced cash flow and a depletion of cash reserves … and voila it is the time when the developer/owner/syndicator is trying to get the loan rewritten or actually starts shorting the payments to the lender (simultaneously they often are trying to sell their still somewhat performing properties in order to obtain CASH liquidity – the non-performing ones often, ?usually?, are not sellable).

  4. Bank Frank says:

    Great post, nice chart.

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