Commercial Real Estate Problems Piling Up

Published September 1, 2009

Following hard on the heels of the falling housing market is the commercial real estate market.

According to the MIT Center for Real Estate, commercial real estate values have fallen for four consecutive quarters, with sales transaction prices dropping nearly 26 percent. Commercial real estate prices fell 6 percent in the first quarter of this year, the most recent quarter for which full figures are available.

With retail sales and the job market remaining weak, economists do not expect a significant recovery any time soon. The declining values also will cause further losses in local tax revenues.

Major Bankruptcy

One indication of the distress showed itself in mid-April, when Chicago-based General Growth Properties, which owns more than 200 shopping malls across the country, filed for bankruptcy protection. Further deterioration of commercial real estate will have other far-reaching ramifications, according to industry experts.

“Without a meaningful program to inject funds into the commercial marketplace, a complete commercial meltdown will be far worse than any subprime crisis,” said Morris Missry, an attorney and chairman of real estate with New York-based Wachtel & Masyr, LLP.

$100 Billion More Losses?

Financial institutions could lose another $100 billion in commercial real estate loans before the market finally hits bottom near the end of this year, said Leela Rao, senior vice president of sales and marketing for 1031 and TIC Investments in Minneapolis.

Another effect of the slumping commercial real estate market is that people who hold investment properties aren’t “trading up”—using 1031 exchanges to sell properties and buy others, Rao added. The 1031 exchanges enable investors to defer gains on sales.

“We are seeing a continued decline in the commercial real estate market across the board,” said Ed Mermelstein, managing partner of Mermelstein & Associates in New York City. “When we take this to the level of tax implications, we’re going to see quite a bit of decline in tax revenues. Most municipalities will not be able to absorb these losses.”

More Tax Challenges

Mermelstein said there has been an increase in the number of filings challenging property tax assessments in hopes that lower property values will result in lower tax bills.

Bankruptcy filings are a concern, but municipalities fare better than other creditors. For example, Mermelstein says, General Growth has the wherewithal to pay its taxes, even if other creditors go unpaid.

“Bankruptcy proceedings may not hurt the municipalities as much as they are hurting the creditors, because the tax obligations will be paid first,” Mermelstein said.

Phil Britt ([email protected]) writes from South Holland, Illinois.