Rising Apartment Vacancy Rates Could Threaten Regional Banks

rising-apartment-vacancy-rates-could-threaten-regional-banksApartment vacancy rates soared to their highest level in 30 years in the fourth quarter of 2009. That means more apartment owners could have trouble paying their mortgages, which could lead to an even greater number of commercial defaults. U.S. bank examiners believe losses on commercial real estate loans pose the biggest risk to U.S. banks this year.%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%% First, let's look at what's happening in the rental marketplace. The vacancy rate for 79 U.S. rental markets at the end of 2009 was 8%, the highest level New York research firm Reis has seen since it began tracking statistics in 1980. Rents fell by 3% as vacancies mounted, and landlords tried all kinds of incentives to get and keep tenants.

San Jose, Seattle and San Francisco were among the hardest-hit markets, while New York actually saw an improvement in its vacancy rate. But even in New York City, 60% of rental buildings dropped their rents in the fourth quarter to keep tenants. Effective rents in the city, which include the value of concessions such as one month free rent, dropped by 5.6%, their largest decline since Reis started monitoring that stat for New York in 1990. To an increasing degree, concessions such as shampooing carpets and painting accent walls are becoming a common part of lease negotiation.

Reis found that vacancies increased in 52 markets and decreased in just 17. Ten markets stayed flat. Tucson, Ariz., Charlotte, N.C., and Lexington, Ky., were the three hardest hit markets.

What's driving the vacancy rates? Several things:
  • As long-term unemployment continues, people are moving in with families and friends;
  • Younger workers are living with their parents while they look for jobs;
  • Older buildings face heavy competition from new construction, which includes both new rental apartments and condo units that did not sell and were converted to rentals. In fact, Reis found that 120,000 new units came onto the market in 2009, the largest number since 2003.
Reis expects the oversupply of new units won't start to be absorbed until 2011. That's because many commercial developers secured financing before credit markets seized up. And that brings us to the other half of the story -- the impact these loans will have on the banking system.

In Play: $3.5 Trillion in Commercial Real Estate Loans

Eugene Ludwig, who was comptroller of the currency under President Bill Clinton, told BusinessWeek that hundreds of banks will fail or be resolved as this cycle winds down. Federal Reserve Governor Elizabeth Duke also raised a red flag on Monday, saying credit conditions in commercial real estate "are particularly strained." And in congressional testimony in October, Fed Governor Daniel Tarullo cited commercial real estate as one of the economy's "key trouble spots."

So how much money is involved? Banks and investors hold about $3.5 trillion in commercial real estate loans, including malls, office buildings and apartments, based on a June 2009 report from the Fed. About $1.7 trillion of that total is held by banks and thrifts. Regional banks are almost four times more concentrated on property loans than the nation's biggest banks, based on data compiled by Bloomberg. In 2009, 140 banks failed, and as of the latest FDIC quarterly report in November 2009, 552 banks were in trouble. Mortgage and commercial lending problems have fueled most of the bank failures so far.

As apartment vacancies mount, even more commercial loans will default, taking more banks down in their wake. Until unemployment turns around, there's little hope that this crisis will dissipate.

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