Treasury official, experts wary of commercial real estate crisis
Nancy Wentzler, left, said observers are waiting for the commercial real estate market to hit its stride.
Knight Kiplinger said commercial real estate is dealing with excess capacity and "is the shoe that hasn't fallen."
Michael Farr said the overall real estate market is fragile and said the economic recovery will take a little longer than expected.


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2:19 p.m., Jan. 26, 2010----Nancy Wentzler, chief economist and deputy comptroller in the Office of the Comptroller of the Currency (OCC), said that while banks started showing slight improvement in their balance sheets in 2009 compared to 2008, the recovery is fraught with risks and commercial real estate is still in the doldrums.

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Wentzler was one of three featured speakers at the 2010 Economic Forecast on Wednesday, Jan. 20, at the University of Delaware.

"We are all waiting for commercial real estate to really hit its stride in terms of credit quality problems and that's very likely to come as we make our way through 2010," Wentzler said. "We are watching that very carefully -- the hotels and you can imagine the multi-family, the apartments, the office buildings -- and significant problems as you would imagine in the boom-bust states like California and Florida and parts of the Midwest."

Headquartered in Washington, D.C., the Office of the Comptroller of the Currency has four district offices and an office in London to supervise the international activities of national banks. Wentzler is in charge of economic and financial analysis of potential risks to the banking system and the development of risk models to serve as early warning tools for such risks.

More than 200 business and community leaders, educators and students attended the annual event, hosted by Lyons Companies and the University of Delaware Center for Economic Education and Entrepreneurship (CEEE), in the Lerner College of Business and Economics.

Wentzler also participated in a panel discussion with the two other speakers, Michael Farr, president of Farr, Miller & Washington, a portfolio management firm in Washington, D.C., and a leading financial analyst and strategist, and Knight Kiplinger, editor in chief of Kiplinger Washington Editors and one of America's most respected economic journalists and business forecasters. James B. O'Neill, University of Delaware professor of economics and director of CEEE, moderated the discussion.

Kiplinger said commercial real estate is dealing with excess capacity, with too much office space, too much warehouse space and falling rents. The value of commercial real estate, which is based on cash flow from rent, has fallen by 35-40 percent and it is getting worse in many communities.

"It's the shoe that hasn't fallen," Kiplinger said. "It will be just as big as the residential real estate debacle over the last couple of years and it is not really on everybody's radar screen quite yet."

Kiplinger added that some of the positive signs in the gradual economic recovery is the shift in consumer spending and saving habits, which caused savings by Americans to drop from a historical rate of about 10 percent to almost zero, and has now grown to about five percent, a "huge improvement over zero."

"Too much of our consumption in the last decade was driven by borrowing -- credit card borrowing and especially home equity borrowing [for] second homes, travel, remodeling, and some better purposes as well; home equity borrowing to fund education and training, a good use of home equity borrowing," Kiplinger said.

Farr reiterated the fragility of the overall real estate market and predicted that the economic recovery will take a little longer than expected. The numbers, he said, paint a grim picture of what lies ahead: 25 percent of all residential mortgages higher than the value of the house, 14 percent of mortgages either delinquent or in foreclosure, and possibly two-thirds of commercial real estate owing more than it is worth.

"I don't think this thing is going to turnaround any time soon," Farr said.

However, Farr expressed confidence in investments, which are favored by, among other factors, a free capitalistic society, favorable tax and demographic environment, a shift in consumer spending and saving patterns, and possible government incentives to save for retirement.

"I think there is money to be made," Farr said. "The key going forward here is this transition from government money to real end consumer demand and I think it's going to tale a lot longer than all of the happy, singing, smiling faces you are hearing in the media right now.

"I think we've seen the worst, at least in terms of the market. This recovery is going to take some time. We can get through it, we shouldn't bet against America and there is money to be made," Farr said.

Wentzler said in addition to the cyclical effects in the economy, some of the strategic risks that are likely to have a dramatic impact on traditional industries are: Globalization, which spreads the playing field and draws more competition; technology, which has struck at the heart of traditional media and telecommunication; and missteps such as the decision to produce gas-guzzling Dodge Durangos at the now shuttered Chrysler plant in Newark when gasoline prices lingered around $4 a gallon.

Wentzler expressed optimism in the ability of banks to survive the expected losses, but cautioned that areas in the Midwest that do not recover lost jobs might be facing even more dire consequences.

"It is a great deal of concern to us because if the jobs don't come back that means we are going to have greater losses in banks in that area that are going to be drawing an awful lot of stress from credit costs as well as the revenue side."

Wentzler cautioned that the overall economic recovery is only halfway through, largely because of the imminent losses in commercial real estate.

"A lot of people are sort of calling victory here. We're not at victory," Wentzler said. "This is extremely fragile. The good news is that banks have a lot of capital -- much higher than before -- but challenges will be there and we need to recognize that the strategic risks are going to be very high."

Article by Martin A Mbugua
Photos by Evan Krape