Thursday, November 19, 2009

The Commercial Floor Covering Forecast-Another Storm is Brewing

Jim Gould, President Floor Covering InstituteConsensus is that the residential floor covering hurricane has passed and a slow recovery has started. Meanwhile, a tropical storm in the commercial real estate market is quickly brewing off shore and there is reason to believe it will grow into a storm larger than anyone expected. The floor covering industry needs to take note.

Last week I attended the Star Net Worldwide Fall Meeting where several excellent speakers reviewed the past and looked into the future. It was a mix of good, bad and ugly news and since then I've taken a closer look at what is going on in the commercial real estate market which is why I'm writing to you today.

But first, the good news....the newly released McGraw Hill 2010 Construction Outlook says that overall construction should increase 11% in 2010; a welcome change. They say the residential construction market is on its way back:
  • Single family constructions has already bottomed out. A projected 30% increase in units in 2010 will take us back roughly to the 2008 level. In 2009 new units fell below 600,000; the expected 780,000 units is still well below a sustainable building rate of 1.2 million units per year, but it's moving in the right direction.

  • The multi-family sector took a huge hit in 2009, down 55% in units. It is expected to slowly turn up next year with a 14% increase.
Unfortunately, that is where the good news ends. Here is where the picture can turn bad or even ugly, depending upon what happens with commercial lending and commercial default rates.

Outlook for the Commercial Real Estate Market

In 2009 commercial construction was down 43%. If everything stays on course we could see a 4-5% increase in 2010, according to McGraw Hill, although no substantial recovery is expected until 2011. Health care, military and federal buildings will be the bright spots largely due to the stimulus package. Retail and hospitality construction will continue to decline.

The new and looming threat on the horizon just now being recognized is the growing commercial default rate. The "chatter" is saying "a crisis of unprecedented proportion is approaching" others that it is a "tsunami is unfolding." Here is why.

Currently there are $83 billion in commercial property defaults and that number is expected to double by the end of this year. So far, banks have only foreclosed on about 10% of these loans and are moving slowly to recognize further losses on their books. Commercial property prices have fallen 30-50% from their peak in 2005, wiping out the equity that owners had to finance in the first place.

Between $1.0 and $1.4 trillion in commercial property loans will need to be refinanced over the next few years and more than half of that is expected to be "under water." Zisler Capital Partners, who focus on real estate investments, estimate that building owners will default on more than half of these loans since much of the property will be worth about half of its originating value. If this happens, some banks could end up insolvent as they reduce their holdings.

The Federal Reserve Bank is apparently concerned as evidenced by their recent extension of the TALF (Term Asset-backed Loan Facility) program to the middle of 2010. TALF is designed to increase lending through asset-backed securities. Because of the tight restrictions on this program however, it may not benefit small developers or local commercial property owners with heavy debt loads - the primary customers for most commercial floor covering businesses.

Not trying to scare anyone but it may be time to pull out the commercial grade rain gear and prepare, just in case, for Round Two of a very stormy season.

I am very interested know what others are thinking about this, especially leaders in our industry such as Mohawk, Shaw, Armstrong and Interface, and anyone who is watching this development.

Jim

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2 comments:

  1. Jim,

    I appreciate your thoughtful analysis of the current condition of commercial financing and the effect on projects that are “on the bubble”.

    In the Pacific NW, our company is seeing growth in the smaller projects with independent financing. They are moving forward as they achieve approval by developers.

    The large or Mega projects are definitely on hold due to money “rationing” by commercial lenders.

    This region could surely be more positive if the Political situation was clearer to all concerned.

    Regards,
    Clay

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  2. Clay,
    Thanks for the insightful feedback. I hope others will also share their thoughts and experiences.
    Best regards,
    Jim

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