Commercial Real Estate Market Creates Nasty Bank Hangovers

For nearly two decades, Seattle’s economy, led by the real estate market, was on a bender. With momentary bouts of sobriety in the early 1990s and post 9/11, Seattle partied day and night. Prices rose, jobs were plentiful, cash and credit were easy.

But all great parties have to end and you wake to face the morning after, when you often struggle to remember just what you did and why. And almost instantly you can feel the regret streaming in.

Seattle’s morning after is still in its early stages; we’ve barely woken up and things are still a blur. Did we really lose the Sonics? To Oklahoma City? Did we really build a streetcar in South Lake Union? Thank God, I’ve got my money in WaMu! Did I really spend $600,000 on an 800-square-foot condo with $800 HOA dues?

The terrible realities of that last question are coming into focus. This morning, Seattle Times reporter Drew DeSilver wrote about Sterling Bank's current trouble: too many bad commercial real estate loans. The Feds have ordered Sterling to raise $300 million dollars by December 15. Sterling responded by firing their CEO and pledging to raise capital.

Sterling isn’t going it alone as a bank in trouble because of the commercial real estate market. It’s been a bad year for local community banks all over the state. During the height of the real estate party, it made sense for these banks to loan money to commercial developers, particularly residential developers. Seattle leaders threw around words like “urban density” and handed out permits like an East Texas patrolman hands out speeding tickets.

With willing lenders and compliant public leadership, condo projects, apartment buildings, townhouses and mixed-use retail and residential buildings sprouted up all over town. Prices rose and it looked like the party would never end. More and more loans went out to commercial developers, who also started more plans for retail malls and office buildings to house hungry and shopping-happy workers.

But the party ended and nowhere has the lingering hangover been worse than in the condo market. Condos have never been considered the safest real estate investment. Historically, condos are hard to resell, so the inflated prices fell harder in that market than in single family homes. Completed projects, like Brix on Capitol Hill, have turned to auctioning off properties at bargain prices.

Other projects have converted to rental units, but struggle to find renters. Prices across the board have fallen hard. Those buyers who purchased on the way up, are now facing vastly decreased values and will no doubt have to hold on to their condos for many years in the hope that values will, one day, return.

With lots of completed units looking for buyers or renters, the market for new construction collapsed. Last week, Seattle Times reporter Eric Pryne reported that Starwood Capital Group, which had dug a huge hole in an old parking lot on the corner of Second Avenue near Pine Street to make way for a $200 million hotel and condominium project, was giving up on the project and filling the hole back in. It was kind of sick joke version of the old WPA era idea that workers would dig a trench in the morning, break for lunch, and then fill it in. But it demonstrated how weak our market for condos had become.

Many other new construction sites were funded by loans from local community banks like Sterling, and many of those loans are now going bad. Washington Federal had to raise an initial $300 million by issuing new stock and Columbia raised $125 million to hedge against bad loans. DeSilver points out that up to 19 other local banks are facing closer Fed scrutiny.

Looking closer into the nation’s banking sector is bound to make the headache worse. In an AP story today, reporter Stevenson Jacobs pointed out that our major national banks aren’t making money on traditional loans, like mortgages, or other traditional sources of income like fees on checking accounts. Banks like JP Morgan Chase and Goldman Sachs are making money by betting on stocks and bonds. If that sounds like the kind of behavior that got us into this recession, you are right.

Pundits are happy to tell us that the recovery is on the way, if it’s not here already. The market rallied to over 10,000 this week, partly on positive earnings news from JPMorganChase. Too bad slaphappy investors didn’t want to look behind the curtains at the man with his hand on the lever.

JPMorganChase is making money on investments, after a huge handout from the Feds, but their core business of lending money for mortgages is weak, and perhaps getting weaker. That’s also true in the credit card business, until recently a huge moneymaker for banks. Bloomberg reported today that all the major credit card companies could show record write-offs this year. 

The current "recovery" has all the makings of a stock market bubble. This wouldn’t be the first time a severe economic downturn has a mid-cycle upswing. In the 1930s, the market rallied in 1934 and '35, only to fall again in 1937. It’s clear this week that the banking system is still in trouble and the lingering pain is strongest here in the Northwest.

When the nation’s economy started declining in 2007, local leaders said Seattle and Bellevue were immune. Then they said we would have a shorter recession and come out of quicker. Now they’d have us believe we are recovering.

History says that this region is always late to the party and the last to leave. It doesn’t look like this time is any different. Even if the rest of the country starts its climb back, Seattle, burdened by sagging commercial real estate prices and banks slowly, painfully getting those commercial real estate and construction loans off the books through government help, issuing new stock or finding new investors willing to hand over the dough, may take much longer.