As commercial real estate sales and construction surge across the U.S., officials are increasingly worried that banks are carrying more real estate loans today than during the 1980s boom — which resulted in a rather hard landing when the bottom fell out of the market.

What the government is planning on doing about this has left some community bankers shaken.

Regulatory agencies such as the Federal Reserve, the FDIC, and the Office of Thrift Supervision, are working on guidance that would implement a range of risk-management controls, such as strongly encouraging banks to have more capital on hand if they are carrying a significant amount of loans tied to the potentially volatile commercial real estate market.

To identify whether a particular bank’s portfolio is becoming overly dependent on commercial real estate loans, the guidance sets several thresholds:

• Banks with construction or development loans totaling 100 percent or more risk-based capital would qualify as what regulators term a potential concentration.
• Banks with construction, multi-family home and commercial real estate loans totaling 300 percent or more also would be overly dependent on such loans, in regulators’ estimation.

If these thresholds are met or exceeded, then a bank would need heightened risk-management practices, such as establishing clear risk standards, increased oversight by their bank boards, having adequate capital and reserves, and planning for downturns.

About one-third of all U.S. banks meet the thresholds laid out by the regulatory agencies. But Steve Fritts, the associate director of policy for the FDIC, is concerned banks haven’t installed the adequate information management systems and management techniques they need.

“We wanted to make sure that as banks grew, they had the tools to grow the commercial real estate business line,” Fritts said.

But the proposed guidance is too vague, too simple and too broad, some community bankers argue.

“Don’t paint all the banks with the same brush. We already have very vigorous standards in place with risk-based capital,” Alan Rowe, President of the First Commercial Bank of Florida, said.

It’s also important to look at the types of commercial loans a bank is making, adds Craig Polejes, President of Florida Bank of Commerce, which has 50 percent of its loan portfolio tied up in commercial real estate. For example, there are differences in risk between an owner-used mortgage and real estate investments.

Rowe and Polejes share a concern that exceeding the thresholds will automatically result in a forced capital increase for Florida banks, but Fritts says that’s a common misunderstanding of the new policy.

“If the nature of the loan is more high-risk or low-risk, then they need more capital. It wasn’t meant to be automatic, he said.”

Financial markets tend to react unpredictably when faced with mixed signals, and commercial mortgages are no exception.

Competing signs in recent weeks include a lackluster May employment report (pointing to a weaker economy), and Federal Reserve Chairman Ben Bernanke indicating that he still views inflation (or an overheated economy) as a serious threat. The result has been quite a bumpy ride in the U.S. stock and bond markets.

U.S. Treasury bond yields have ranged significantly, but have fallen over the past 30 days, bringing Florida home loan rates down slightly with them. The Barron’s/John B. Levy & Co. National Mortgage Survey, a gauge of commercial lending activity, showed that commercial mortgage rates are now in the 6-6.15 percent range for 5- and 10-year loans.

Real estate has become a favored investment class in recent years and remains so even in these turbulent times. But storms are on the horizon.

Rising interest rates have pushed fixed-rate mortgages up more than 1 percent since June 2005, which is a trend that could make commercial real estate values suffer.

The interesting dynamic here is that with all the talk of a downturn, property values are not suffering because so much money is clamoring to get in. Pressure is building. A recent Wall Street Journal article described a short video circulating on the Internet showing a Hong Kong bus incident.

The video, which is becoming the Zeitgeist for these times and has been dubbed “Bus Uncle,” is named for the elderly man captured on film berating a younger man who had asked him to keep his cellphone conversation down. The essence of the scene was “I have pressure, you have pressure.”

The phrase could easily describe real estate investors pressing things to the limit and fighting a few trends against them. Rising rates are clearly the single largest factor pressuring deals, while a second, lesser-followed pressure point is the rise in insurance premiums, particularly in coastal areas.

The start of hurricane season has brought renewed attention to the damage and destruction of coastal properties in the past few years and the havoc insurance companies felt as a result. Property owners are getting bills which some describe as crazy. One owner spoke of a sevenfold increase in premiums for a major property in Florida.

Another West Coast-based national real estate developer that purchases and develops apartments in Florida indicated that:

1. It cannot buy Florida real estate properties that are stick built.
2. It can only buy properties in Florida after selling others under their blanket policy.
3. Although it will probably blow over in a few years, underwriting insurance premiums is a challenging and risky business that puts pressure on their projections and could reduce values (sellers have not reduced their value expectations, however).

More than just people in the coastal areas will feel the pressure of rising property insurance premiums. In addition to tax dollars that go to support hurricane victims, commercial real estate owners can expect premiums to rise as companies seek to make up for losses in coastal areas by raising rates in less risky areas.

Just how hot is the commercial real estate market in Florida? It’s been attracting companies from across the country. According to a pair of recent economic reports, this success is a trend around the country.

Projections for commercial real estate in 2006 appear strong. The “Real Estate Industry Outlook” by PNC Financial Group Senior Vice President Nick Buss and the “Commercial Real Estate Outlook” of the National Association of Realtors both anticipate a good year for commercial real estate, driven primarily by job growth and international trade.

Both Mr. Buss and the national association expect average vacancy rates nationwide to drop and rents to rise in all five of commercial real estate’s major categories:

1. Retail
2. Office space
3. Industrial
4. Multifamily
5. Hotels.

The National Association of Realtors report noted that investors poured a record $268 billion into commercial real estate last year, up 44 percent from 2004.

“Investors’ love affair with real estate is still very much alive, but the risk is that that, too, can quickly change,” Mr. Buss said.

The multifamily housing and retail sectors are at greatest risk: multifamily because for the past year the supply of rental units was diminished by a wave of condominium conversions, which may not continue; and retail because consumers may cut back on their spending, much of which has been fueled by home equity loans that are becoming less attractive as interest rates rise.

Commercial and industrial real estate remains scarce across South Florida, resulting in higher rental rates and giving owners even more leverage than they have previously enjoyed. A lack of new office construction in Palm Beach and Broward counties is keeping vacancy rates near 12 percent. Rather than renting in this tight market, some small business owners are buying office condominiums, according to the Ft. Lauderdale Sun-Sentinel.

“Rental rates are increasing in both counties and are expected to increase. I think people who have historically signed three- to five-year leases will want to lock into more long-term deals. Rates are only going to go up,” said Paul Marko, vice president of CB Richard Ellis in Fort Lauderdale.

Marko and colleague Harry Tangalakis are scheduled to discuss their ‘06 office and industrial outlooks Thursday at the 14th annual Institute of Real Estate Management Economic Forecast Breakfast at the Renaissance Boca Raton Hotel. Tangalakis has said that Broward’s industrial market, which consists of 97 million square feet, is 4.5 percent vacant. The 48 million-square-foot industrial market in Palm Beach County is 2.5 percent vacant.

“I’ve been doing this for 24 years, and I’ve never seen the market as tight as it is today,” Tangalakis said. “[Commercial real estate] really is a seller’s market. Landlords are not giving any concessions at all. It’s a take-it-or-leave-it scenario right now.”

In addition, industrial land prices have escalated to $10 to $12 a square foot in Palm Beach and Broward counties, causing some firms to look to less-expensive Orlando and Jacksonville real estate.

Lifestyle or downtown centers are dominating development in Broward County, particularly west of State Road 7, Crossman said. Investors think fast-growing west Broward will outperform most other facets of South Florida real estate development. Western Palm Beach County also has a growing retail landscape.

The Southern Palm Crossing development in Royal Palm Beach will have 348,000 square feet of shops and restaurants, including a Costco, Marshalls, Home Goods and Stein Mart. Each will be the first stores in the immediate area for the respective retailers. More than a few South Florida shopping centers these days are fetching top dollar, commanding rates more commonly seen in California.

What’s driving all this? Demand. Many landlords across the nation have not been enjoying the real estate boom, but that is changing now as rental markets are heating up. It’s probably no surprise to many in South Florida that office space is scarce in the area. Low Florida home loan rates have fueled residential real estate demand so much that a serious affordability crunch has resulted.

Even as the profitability on U.S. real estate is shrinking due to soaring prices paid for buildings and slowly-rising interest rates, investors will spend $200 billion - a new record - on commercial property this year, according to a survey done by Cushman & Wakefield, a real estate services firm, at an industry gathering in San Francisco.

Despite cooling signs attributed to the real estate market on the residential level, foreign investors, private equity companies and pension funds still see it as a stronger investment than traditional avenues. Since 2000, stocks, bonds and similar options have been viewed as volatile by a legion of investors, and data suggests they are right. The value of the National Association of Real Estate Investment Trusts index, according to the survey, has gained more than 20 percent in the last five years, an extremely healthy return. The Standard & Poor’s 500 index, meanwhile, has fallen 3 percent.

It has been a record growth year for San Francisco, with over $4 billion in closed property sales, second only to New York City. However, home skeptics warn that this market will soon come back to earth, too. Ken Rosen, a real estate and economics professor at UC-Berkeley, said that despite the huge amounts of money flowing into commercial real estate, publicly traded real estate investments are overvalued and due for a fall in the next two years - perhaps a decline of up to 20 percent.

Rosen noted that San Francisco would need to create 15,000 new jobs to “feel healthy” about the current market growth, and that only 8,000 jobs were totaled last year. He said that an 8 percent office vacancy rate and average rents of $50 per square foot are benchmarks for a healthy commercial real estate market, and the current figures are nowhere close. The city’s office vacancy rate at the end of September was 16.5 percent, according to the Cushman & Wakefield, survey, with prime office rents at $31 per square foot.