Office-space demand is gone. Companies aren't expanding, and tenants can take advantage of cheaper rents as well as competition to land them in space finished as the market collapsed.

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This is one of those good news/bad news columns. The good news is that Washington is surviving the commercial real-estate crisis, with strong leasing and building activity. The bad news, of course, is that it’s the other Washington.

Here, the troubles swamping developers, builders and lenders are less severe than in the most overbuilt regions in the U.S., but they’re still a significant drag on the economy. They come with portents, such as a missed mortgage payment on the iconic Columbia Center. And include unrelated misfortune, such as a new Belltown building will probably have to be dismantled for safety reasons — that seems like a symbolic foreclosure notice from the gods.

Downtown Seattle may have hit bottom, after suffering the loss of Washington Mutual and much of Safeco as well as overbuilding. But bottom is a record vacancy rate of more than 20 percent. Some suburban areas are doing somewhat better, although the extent of distress depends on location. Still, average net office rents in metro Seattle fell 8.9 percent in the first quarter compared with the same period in 2009, according to research firm Reis Inc. Offices make up the biggest slice of commercial real estate.

For the entire sector, property values have declined 40 percent since 2007.

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It would be nice to say “don’t even breathe” and hope the situation is indeed stabilizing and can slowly work itself out. Unfortunately, the remaining imbalances and uncertainties in commercial real estate remain one of the biggest risks for a double-dip recession.

Private-sector building and lending have essentially stopped, holding back the kind of activity that could make a real dent in the nation’s unemployment rate. But demand is gone. Companies aren’t expanding, and tenants can take advantage of cheaper rents as well as competition to land them in space finished as the market collapsed.

The tale is told in the Beige Book report on economic activity. For the district that includes the Northwest, the Federal Reserve reported in January that demand for commercial real estate continued to deteriorate. In March, commercial real estate continued to slide. And this month: Conditions eroded a bit further.

Defaults expected

The financial side contains even greater risk. Fitch Ratings said it expects defaults to surpass 11 percent this year on commercial mortgage-backed securities. If that sounds like the kind of “innovation” that mushroomed the housing bust into a financial panic, it is. We just don’t know the full exposure or interconnectedness of these derivatives. Or whether, as Fed Chairman Ben Bernanke once put it, the damage can be “contained.”

One aspect of harm isn’t in doubt: many small banks are failing because of the slow-moving reckoning of commercial loan troubles, costing the Federal Deposit Insurance Corp. hundreds of millions of dollars. For example, the FDIC paid Whidbey Island Bank $110 million to take over City Bank in Lynnwood on April 21. The FDIC also kept $280 million of City Bank’s least desirable assets.

The congressional oversight panel headed by Elizabeth Warren warned bank losses could reach $300 billion a year. About half of $1.4 trillion in commercial loans that will come due over the next five years are underwater, meaning mortgage debt exceeds the property’s value.

In addition, property owners that must refinance will face a much tougher credit market. The debt overhang facing commercial real estate continues to be substantial.

But other factors may weigh against a repeat of the housing disaster: Systemic risks may be lower. The size of the problem is smaller.

Also, according to Greg Martin of the accounting and consulting firm Moss Adams, even distressed commercial properties can generate some cash flow. And with the Great Recession having “broken the back” of new development, new inventory won’t keep coming onto the market.

No new projects

Even optimists say it will be several years before we see major new projects. Some cities that saw excessive speculative building, especially on the exurban fringes such as Phoenix, could take even longer

Still, barring hidden mischief on Wall Street, we have been here before. From offices to strip malls, the vacancy indexes are the worst since the 1991 recession fueled by the savings and loan scandal. Small comfort, but better than so many measures that are the worst since the Great Depression.

The Seattle region benefits from having a diverse economy likely to recover faster than most metros. It was less dependent on real estate than many.

Even so, the damage is, well, real. And recovery for the commercial sector will be slow.

You may reach Jon Talton at jtalton@seattletimes.com