The tough economic conditions in the United States have adversely affected just about every significant industry over the last couple of years. In the case of commercial real estate, while market correction forces are hard at work, the “bubble” has yet to burst.

San Antonio and the surrounding areas have increasingly seen more foreclosures and troubled loans despite the city’s faring better than other major metropolitan areas.

Most people are familiar with the circumstances that caused the downturn in residential real estate, such as easy credit, relaxed underwriting standards, adjustable rate mortgages, widespread speculation and/or a lack of fiscal discipline by many borrowers. Not surprisingly, these same factors have also contributed to the problems with commercial real estate investments and income-producing properties.

Investors gambled that the market values would continue to rise, but alas, the music finally stopped and property values declined precipitously. Big box retail closures, combined with a lack of business expansion resulted in vacant strip centers or lower rent payments, thus creating debt-service challenges for landlord borrowers.

There exists one key distinction between the manner in which residential and commercial real estate issues are being approached: the commercial real estate sector is determined to take proactive measures and implement strategies designed to minimize the prospects of crushing investment losses. Commercial real estate analysts hope a few key initiatives will derail, or at least slow, the troubled loan train, ranging from traditional lender remedies to innovative Web-based initiatives.

While foreclosures remain the preeminent remedy used by lenders and bankruptcy the defense commonly employed by borrowers, the lack of available credit has increased the likelihood that lenders will own the property following a foreclosure sale. As a result, lenders have been forced to look at other options, such as the sale of the lender’s interest in a mortgage and the underlying real estate loan.

In fact, many mid-size real estate lenders have engaged third parties to oversee Web-based auctions, in which a single loan or a loan portfolio is made available for bidding. From a lender’s perspective, the selling of a loan is an efficient vehicle for getting the troubled loan off the books. That is not to say the selling lender will receive sufficient proceeds to pay off the loan. On the contrary, depending on the perceived value of the underlying real estate asset, commercial loans are selling for between 40 percent and 90 percent of the outstanding loan balance. In return, the lender is able to re-deploy the sale proceeds in the form of a new and, at least theoretically, more secure loan.

Loans often change hands between established financial institutions, but the incidence of loan buyers that are not financial institutions is on the rise. In many cases, the buyers constitute private equity funds, often called “opportunity funds” (or more ominously, “vulture funds”), which buy the loans with an eye toward exercising the lender’s remedies under the loan documents and, in many cases, owning the underlying real estate asset.

In rare instances, the borrower may be able to successfully restructure the loan to buy time and ride out the storm. However the lender will attempt to bring the loan in line with its current underwriting standards. As a condition of extending the maturity date and agreeing to other loan modifications, the borrower may be required to reduce the loan’s outstanding balance, cure any material defaults and provide enhanced credit support, typically in the form of a guaranty.

While commercial property owners have a few options on hand, they are also faced with the same complications that homeowners are dealing with, such as tight credit, lower leverage ratios (i.e., loan amount to property value), and underwriting standards and regulatory oversight which are stricter than in recent years.

Additionally, maturity dates on commercial loans tend to range from five to 10 years after loan origination, as opposed to 15 to 30 years for residential loans. Homeowners have a relatively long horizon to recover lost equity; the nature of commercial loans does not afford commercial real estate borrowers the same opportunity.

According to Real Estate Econometrics, commercial loan defaults are expected to peak in 2011. Perhaps more alarming is that delinquencies on commercial mortgage- backed securities (CMBS) rose to a record high to 4 percent in the third quarter, which is six times higher than .54 percent a year earlier, according to a recent report by the Mortgage Bankers Association. It’s expected the delinquency rate on CMBS investments – securities backed by mortgages on commercial properties, such as hotels, apartment complexes or office buildings - could hit up to 6 percent in 2010. One challenge posed by CMBS loans is that, as a result of federal tax law and contractual agreements between investors and the loan servicers, there is very little flexibility in modifying them. However, Congress is currently working to pass legislation that balances the interests off all stakeholders to the CMBS market, including the well-being of the commercial real estate market as a whole.

Working through the volume of troubled loans in the next few years will not be without casualties. Real estate investors, lenders (and possibly taxpayers) alike will share in the fallout. If there is a silver lining to the current conditions, it is that there is broad acknowledgement of the issues in the commercial real estate market and the process of working through troubled loans is well underway.

In the near future, and hopefully for an extended period thereafter, the fundamental lending practices will return to commercial real estate and make the industry more stable.