Bubble Trouble

BLOG VIEW: If you begin typing ‘commercial real estate’ into the Google News search engine, you'll likely see ‘commercial real estate bubble’ appear as one of your first suggested auto-fill options before you've even finished typing the first word.

Google News readers feel the CRE bubble is real (or at least highly search-worthy). However, the question of whether that bubble truly existed – as well as whether its subsequent bursting created the current state of affairs in the industry – proves much more difficult to answer.

The most recent round of the bubble vs. no-bubble debate began in earnest last week, when New York Times columnist Paul Krugman posted a visually startling line graph comparing the 2000-2009 movement of commercial real estate values (based on Moody's/MIT data) to the direction of housing prices (based on Standard & Poor's/Case-Shiller data) over the same time period.

‘From my perspective, the CRE bubble is highly significant,’ Krugman wrote in a short note accompanying the graph. ‘It gives the lie both to those who blame Fannie/Freddie/Community Reinvestment for the housing bubble, and those who blame predatory lending. This was a broad-based bubble.’

University of Chicago economics professor Casey B. Mulligan revisited the bubble question in a subsequent New York Times blog, calling into the question the validity of Krugman's assertion.

Breaking down construction activity by sector – residential spending and nonresidential spending – Mulligan pointed out that nonresidential construction spending rose only after residential spending fell in 2006.

A simultaneous double-bubble situation would have meant construction activity boomed in both sectors at approximately the same time.

‘I see little evidence of a commercial real estate bubble that was inflated with the same fuel as the housing boom,’ Mulligan concluded. ‘Rather, commercial real estate seemed to be reacting to the situation in the housing sector and in the wider economy.’

Commercial real estate finance executives and supporters are fond of noting that even during the headiest times in recent years, commercial mortgage lending never reached the irrationally, aggressively risky levels seen in the residential mortgage space. No-doc loans? Subprime? Not here.

If lenders, deal originators and borrowers are blameless – and the CRE bubble's existence is uncertain – what caused the collapse, then? Can the entire blame be shifted to the U.S. economy?

Megan McArdle tracked the curious, complex trajectory of the CRE downturn (with or without that bubble) in the January/February issue of The Atlantic.

The article, titled ‘Capitalist Fools,’ examines how experienced financial professionals wound up participating in a mortgage meltdown mirroring that of greedy and/or clueless homeowners.

‘One of the most persistent narratives of the recent crisis portrays a nation of unsophisticated home buyers led astray by greedy bankers,’ she wrote. ‘Supposedly, those bankers were willing to write risky loans, because they intended to pass them on to some unwary investor.

‘But this explanation falters in the face of a legion of failing commercial deals,’ Ardle continues. ‘Prospective landlords had all the expertise they should have needed to put a fair price on properties, and the majority of lenders who were originating loans for their own portfolios had ample incentive to perform careful due diligence.’

Experience, expertise, a clear rationale for sufficient due diligence and a lack of blatantly impractical loan products, however, appeared to be no match for an untimely infusion of simple idiocy, and that mentality may have led to, yes, that CRE bubble.

‘Though the commercial real estate bubble was smaller in scope than the residential one, it was characterized by essentially the same pathologies: rising prices, stupid banks and stupid borrowers,’ McArdle suggested in a subsequent column.

Meanwhile, a few commenters on Krugman's NYT column pointed out the role of commercial mortgage securitization – and its dangerous risk-transferral tendencies – in this bubble (and bubble-bursting) debate.

After all, a loan that has been sliced, packaged, re-packaged and sent far away to an investor arguably causes far little cause for caution than a deal that the original parties will continue to hold.

What do you think? Was there a bubble? How did it inflate, and who punctured it?

– Jessica Lillian, editor, Commercial Mortgage Insight


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