General Growth (GGP), the big mall owner, filed for bankruptcy, as many experts thought it would. The company has $27 billion in debt and, with real estate prices depressed, it may be impossible to raise even close to that amount of money through asset sales.

As would be expected with any large commercial real estate enterprise, General Growth is highly leveraged and was probably able to get mortgages with ease at the height of the real estate boom.

According to The Wall Street Journal, “The bankruptcy will have far-reaching implications for the mall industry, including putting pressure on already declining property values of U.S. malls, and subsequently mall mortgages.” Put another way, the commercial property business is about to be hit by a domino effect. Prices drop, defaults rise, and more properties have to be sold, so prices drop again.

Malls are only the tip of the commercial real estate iceberg. Large office buildings in the nation’s biggest cities are experiencing growing vacancy rates and a raft of tenants who are behind on their rent payments, or worse, have defaulted. Replacing the tenants is difficult without dropping rents significantly which further compromises the ability of these office building owners to make their own mortgage payments. In is not unlike the problem mall owners face as retail outlets close due to lack of sales.

General Growth owes billions of dollars to Citigroup (C), Deustsche Bank (DB), and Goldman Sachs (GS). It is very likely that every large money center bank and investment house has loaned money to commercial property owners because not so long ago the value of these assets was rising sharply every year.

Bank investors has been waiting to see if there is another shoe to drop in the chain of troubled earnings reports. The firms may face more write-offs of toxic assets and pressure from the deteriorating chances that consumers can pay their credit card bills, but commercial real estate may eclipse those problems as the year wears on.

It is not clear whether the government looked closely at commercial mortgage loans when it did its “stress tests” on banks. It is also not clear what assumptions the government used for the default rates of this paper. The $27 billion in debt that General Growth holds seems like a great deal of money.  But, looking at all of the commercial real estate holdings across the country, particularly those with mortgages taken out between 2003 and 2007, and the problem is deeper than most people can imagine.

Douglas A. McIntyre

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