Now that major markets worldwide have completely recovered from the Dubai debacle of last week, it is easy to consider this episode just another blip on the way to eternal bliss. Not even the U.S. dollar could sustain more than a mirage of strength on this “temporary crisis” (I had thought that even after the market ceased to care specifically about Dubai, increased risk aversion would linger). However, the passing of this incident did not demonstrate the resiliency of the global economy. As many have noted, Dubai is only a tiny, maybe even insignificant, part of the global economy. In fact, by many accounts, Dubai appears to be a very unsustainable city-state that seems doomed one way or another (for example, see “The dark side of Dubai” written April, 2009). I suspect the market in general wrote off Dubai a long time ago…even if its lenders have not yet officially taken that step.
However, Dubai has served as a warm-up or demo stage for what potentially awaits the global economy when the fall-out from bad commercial real estate (CRE) loans finally arrives in various countries across the globe. In Dubai’s case, the central government of the U.A.E. appears unwilling to take on the full responsibility for the bad loans of luxury gone wild. Similarly, governments worldwide, already bloated with the burdens of massive transfers of private debts into public debts and obligations, will have a hard time swallowing whatever burdens await when debtors are unable to refinance commercial real estate loans, especially the most speculative ones.
Will Swarts quotes several real estate analysts in “Did Dubai Signal the Next Bump in the Road?“. In particular, Jack McCabe of McCabe Research & Consulting provided some poignant thoughts:
“‘Dubai shows how real estate has such a strong effect on global economies now…Dubai is a warning beacon for the next real estate bubble – one made of offices and retail spaces – for which anywhere from $750 billion to $2.2 trillion in cheap financing will come due within the next three years. That debt was used to finance all kinds of developments around the world, both directly and through commercial mortgage-backed securities. When it comes due, the global recovery may well be in a world of hurt.
During the boom, everything doubled in value when it shouldn’t have, and all of that was facilitated by credit, not by an increase in real value…Now we’re going to see the effects in the commercial markets, and it’s going to be very severe. So many of these projects were financed with five- to sever-year financing, and that’s just now coming up to be refinanced. But now, the money’s not there.”
We already know from corporate earnings reports from the last two quarters that commercial real estate remains extremely weak and expectations are very low for 2010 (click here for an example from July). Even the Federal Reserve continues to point to weakness in this sector as a point of concern. Here is a relevant quote from today’s Beige Book release:
“Commercial real estate conditions were widely characterized as weak and, in many cases, deteriorating further. Market conditions were reported to have weakened in virtually all Districts, with rising vacancy rates, downward pressure on rents, and little, if any, new development. Expectations for 2010 were also quite low.”
The last Federal Reserve minutes also noted several points regarding weakness in the CRE sector:
“Regarding the TALF [Term Asset-Backed Securities Loan Facility], the staff indicated that auto and credit card asset-backed security issuance was increasingly being funded by non-TALF sources; however, commercial MBS remained more dependent on TALF financing…
…The responses to the October SLOOS [Senior Loan Officer Opinion Survey on Bank Lending Practices] indicated that banks continued to tighten standards on commercial and industrial (C&I) loans to firms. Meanwhile, conditions in the nonresidential construction sector generally remained quite poor. The recent trend in architectural billings was consistent with further declines in nonresidential construction, and employment in the sector continued to decline. The October SLOOS suggested that financing for new construction projects was very difficult for businesses to obtain.”
In other words, the on-going weakness and looming defaults in commercial real estate are some of the worst kept secrets embedded in the on-going economic recovery. So far, the financial markets have shown little concern. The Dubai blip provided a brief window on tomorrow’s potential tubmle when the markets finally start to care.
Be careful out there!
Full disclosure: no positions