Commercial property hits the front page

Stories of commercial real estate distress in the U.S. are mounting. As the residential real estate fallout takes form, commercial real estate has come under pressure as well. The Wall Street Journal has a front-page story out today that highlights the situation in the Sun Belt. We should see the distress in commercial property in bank writedowns very soon.

Flamboyant real-estate financier Scott Coles penned a farewell letter, put on a tuxedo and climbed into bed, where he was later found dead in what police believe was a suicide. The tragedy last month is drawing attention to the condition of the nation’s commercial real-estate market, which is beginning to show mounting signs of distress.

Mr. Coles, who was 48 years old, had built his company, Mortgages Ltd., into one of Arizona’s biggest private lenders during the real-estate boom. It specialized in short-term, high-interest-rate loans to commercial developers — builders of malls, office parks, condominiums and other projects — who either had bad credit or a need for quick cash with no red tape. But he overreached, and the debacle that has devastated the U.S. housing market the past year is now squeezing Mortgages Ltd.

To keep growing and outrun the problems, Mr. Coles leaned increasingly on loans — totaling roughly $200 million — from an obscure company, Radical Bunny LLC, run by his accountant. He also sought to raise new money on terms that undermined his existing investors. These moves triggered the departure of several senior managers at the firm in recent months.

So far, the commercial-property market has been spared the devastating losses felt in the housing market because there wasn’t flagrant overbuilding. But declining property values and a weakening U.S. economy are starting to bite: Mortgages Ltd. and other lenders are reporting a significant jump in loan defaults. That’s placing enormous new pressure on the lenders, which have bet billions of dollars on new construction of commercial properties.

“Scott got overly optimistic and thought the good times would go on forever,” says Elliott Pollack, a prominent Scottsdale, Ariz., economist and real-estate consultant who invested in Mortgages Ltd. “The world changed, and it’s going to crush a lot of other lenders in the country.”

–WSJ, 16 Jul 2008