One of the oldest maxims of the commercial real estate business is that it's slow to lapse into recession and slow to come out. The main reason is that lending and leasing cycles tend to lag developments in the real economy by one to two years on average. As Susan Feyder wrote in the Star Tribune on Friday, the toll in Hennepin County ratcheted up significantly in 2008, with foreclosures rising 60 percent in the commercial/industrial sector and 16 percent in apartment buildings. There's worse to come as more leases expire, more tenants default, and more owners go shopping for refinancing deals in drastically tightened circumstances. In the words of one longtime local CRE professional we'll call Bob (not his real name), "The availability of capital is ingrained in the American economy. Shut off the faucet and everybody who's a big user has got a problem."

The commercial real estate crisis is marked by the same cycle of declining values--coupled with market fears of the complex securitization devices used to finance the bubble--that has sunk the housing market. The so-called commercial mortgage-backed securities (CMBS) market that financed so much of the easy flow of dollars through 2007 or so has entirely dried up: According to data compiled by JP Morgan Chase, CMBS issuance fell 95 percent in 2008.

"The fact that the finance markets are gone is creating a critical issue about whether [developers] are going to be able to refinance to do what they need to do," notes Bob. "That's one piece. The second piece is, if you do find the money, they probably will only want to do 60 percent of the value, and you might have a loan that has 75 or 80 percent of the value, so where's that other 20 percent of the equity going to come from? That's the biggest unknown in our markets today.

"In the normal world, you put 20 percent down and finance 80 percent. And if you're being aggressive, you put what's called mezzanine financing on 81 through 85 percent, or 81 through 90 percent, which is more expensive. Now you go back to the bank, and the bank says, well, we're only going to lend 60 percent this time. If my original loan is 75 percent, then I've got a delta I'm going to have a problem with.

"Retail is perceivably the hardest hit because of the number of bankruptcies in the retail space. But there are office buildings and industrial buildings where there are real challenges also. And the problems with finance get exacerbated because the users, the occupiers, of the space use finance to drive their business. And many of them don't have the amount of surplus working capital that's required under the new world order that's been imposed. Where do they look? They'll often look at the landlord and say, I can only pay two-thirds rent."

Of the five major commercial real estate categories--retail, hotels/hospitality, office, industrial, and multi-family--all stand to take major hits in 2009. "Retail space is the most obvious," says Bob. "That's the most visible to the general public. When a Linens N' Things goes belly up, or a Circuit City--that's really visible, and those are big spaces. In the past, we've always had another cadre of retailers to come in and fill the gap, and in this situation, I don't know that there's a list of those retailers that are there to fill in. What might happen is that when leases are up, the tenants will use the opportunity to shop around and improve their lot. They'll find a piece of real estate that they think is a little better.

"About 50 percent of the loans that were generated in the commercial real estate market up until the last year was in commercial mortgage backed securities. Those CMBS loans were in fact sold off in strips, not dissimilar to the subprime deal. There's a real problem in the respect that multiple people own the loan, the servicer plays a role between the loan and the people who own the loan. And there's a problem there because if I own the second tranch and I really want my money, then I'm devaluing the other tranches. It's going to be real interesting to watch it play out. I think the workouts are going to be complicated this time around."

And, of course, a failed refinancing is a bankruptcy waiting around the corner. The commercial real estate crash that's now starting to bloom has implications not only for banks and developers, but for employment and local tax bases as well. As a matter of scale, the National Association of Realtors claims that "[t]he commercial sector provides more than 9 million jobs and generates millions of dollars in federal, regional, and local tax revenue. Local governments, in particular, depend on this revenue for roughly 70 cents out of every dollar in local government budgets."

Just what local governments need: an eroding property tax base at a time when state funding cuts mean more and more pressure to raise additional money from property taxes.