January 2010

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Commercial Realty Lending: Gloom but not Doom

By Dave Kaytes

Predictions of a commercial real estate crisis have circulated for better than a year. While a downturn is likely, it won’t be as bad as doomsayers are predicting. Unlike the residential crash, the downturn will be concentrated in small, community financial institutions rather than regional or national banks.

The fear of a commercial real estate crisis is an outgrowth of the recession caused by the crash in the residential market. While the similarities are compelling, there are some important differences between the two.

The residential lending market was as much a trading and investment crisis as a loan crisis. Mortgages were deconstructed and synthesized as high quality investments, where they were resold to large and small banks.

When the default rates exposed the sub prime quality of these instruments, bank capital fell in large and small banks together. Fannie Mae and Freddie Mac became wards of the state, and the big mortgage banks – WAMU, NatCity, Countrywide, Wachovia – were driven into shotgun weddings with stronger institutions. Only banks with diversified businesses thrived.

Commercial real estate by contrast is significantly more concentrated in smaller banks, with less repackaging of loans. And the risk of these loans is likely to be worse for small banks.