Red Roof and the coming commercial real estate meltdown

Red Roof Inns logo Red Roof Inns scared the bejesus out of investors when it was reported that the operator of budget-priced motels had defaulted on four loans totaling $361.4 million.

Worries about the commercial real estate market are starting to eclipse worries about consumer spending that have permeated the psyche of the investing public. Their worries are understandable given that default rates on commercial real estate loans are at a 15-year high because demand for the properties is weak. Tenants have difficulty paying their rents, and hotels and motels are getting pinched by declining business travel.

Real Estate Econometrics estimates that the default rate for commercial real estate mortgages held by regulated depository institutions rose to 2.25 percent from 1.62 percent in the fourth quarter of 2008. The firm "sees the default rate rising to 4.1 percent by the end of the year, up from its previous forecast of 3.9 percent." By the end of 2010, "the default rate is expected to rise to 5.2 percent, up from estimates of 4.7 percent," according to Property Wire. Analysts expect the default rate for U.S. commercial real estate to peak at 5.3 percent in 2011, up from its forecast of 4.8 percent.

"Certainly we have some significant concerns about commercial real estate loans and mortgage-backed securities," said Christopher Cornell, an economist with Moody's, in an interview with DailyFinance. "Many of them (commercial real estate sectors) are equally up the creek . . . I would expect delinquency rates to go up."

Red Roof, which has 345 properties in 36 states, said that it was entering into discussions to restructure its debt. "While the company is profitable on an operating basis, Red Roof believes that a debt modification is the best way for the company to manage through the current downturn and position itself for future growth," the company said in a statement.

The lodging chain said the discussions "have been highly constructive and we expect a positive resolution in due course." Red Roof declined to elaborate further.

The question is not whether commercial real estate is the next shoe to drop, but when it will drop.
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