Office vacancies loom as problem

Decline in values next woe for banks

An office tower under construction in downtown Houston. Vacancies are suddenly climbing in the Texas city, which had been shielded until recently by skyrocketing oil prices. (MICHAEL STRAVATO/THE NEW YORK TIMES)

Vacancy rates in office buildings exceed 10 percent in virtually every major US city and are rising rapidly, a sign of economic distress that could lead to yet another wave of problems for troubled lenders.

With job cuts rampant and businesses retrenching, more empty space is expected. Rental income would then decline, and property values would slide further. The Urban Land Institute predicts 2009 will be the worst year for the commercial real estate market "since the wrenching 1991-1992 industry depression."

Banks and other financial companies have not had the problems with commercial properties in this recession that they have had with residential properties. But many building owners, while struggling with more vacancies and less rental income, will need to refinance commercial mortgages. The persistent chill in lending will make that difficult - even for borrowers who are current on their payments - setting the stage for loan defaults.

The prospect bodes poorly for banks, along with pension funds, insurance companies, hedge funds, and others holding the loans or pieces of them that were packaged and sold as securities.

Jeffrey DeBoer, chief executive of the Real Estate Roundtable, a lobbying group, is asking for government assistance and warns of the potential impact of defaults. "Each one by itself is not significant," he said, "but the cumulative effect will put tremendous stress on the financial sector."

Stock analysts say commercial real estate is the next ticking time bomb for banks, which have already received hundreds of billions of dollars in capital and other assistance from the federal government. Big banks each hold tens of billions of dollars in commercial real estate securities. They also invested directly in properties.

Regional banks may be an even bigger concern. Over the past decade, they barreled into commercial real estate lending. The proportion of their lending that is in commercial real estate has nearly doubled in the past six years, according to government data.

Just as home loans were pooled, then carved up and sold to investors as securities over the last two decades, commercial property loans were repackaged for the financial markets. In 2006 and 2007, nearly 60 percent of commercial property loans were turned into securities, according to Trepp, a research firm.

Now that the market for those securities has dried up, borrowers cannot easily roll over loans that are coming due. By many accounts, building owners have been caught off guard.

Rising vacancy rates were expected in Orange County, Calif., a center of the subprime mortgage crisis, and New York, where the shrinking financial industry dominates office space. But vacancies are also suddenly climbing in Houston and Dallas, which had been shielded until recently by skyrocketing oil prices. In New York, where rents had risen the highest as financial companies gobbled up office space, vacancy rates are floating above 10 percent for the first time in years.