The Official Blog of Matthew L. Adler

The Official Blog of Matthew L. Adler

Is Commercial Real Estate Next?

The cliché I hear most often these days is that “commercial real estate is next.” I assume it’s being used to make a direct comparison to the distress in residential markets. I just don’t see a lot of similarities between the current residential and commercial markets, however.

Residential real estate is largely the cause for our international economic crisis commercial real estate is merely a symptom. Over-building, investor speculation and insane lending were the catalysts for a global recession, the likes of which the world has never seen.

Yes, commercial real estate owners face significant challenges. The triple threat of cap-rate deflation, maturity defaults and tenant performance are daunting. However, commercial real estate doesn’t have close to the same absorption issues residential is facing. We just didn’t see excessive speculative development in the last 20 years.

In addition, although lenders got carried away in commercial, we are not talking about negatively amortizing 100% loan-to-value (LTV). At its worst, commercial lenders were originating debt with interest only at 80% LTV. However, those loans still had debt service coverage ratios. The threat in commercial real estate, by in large, is with maturity defaults; an inability to replace debt at the end of the term. This is far different from the 50% or worse write-downs we are seeing with some residential projects.

This is going to be a challenging time. Commercial properties will continue to lose occupancy and experience lower market rents. Retail and Class A offices will certainly be the hardest hit. Although the distress in commercial real estate will be painful, it will be nothing like the disaster we have seen in residential.

This economy is challenging enough and simplifying conditions to cute clichés may serve the needs of the commentators and pundits, but doesn’t serve the public good. No, commercial real estate is not immune from the economy, but it certainly isn’t next.

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One Response to “Is Commercial Real Estate Next?”

  1. Jacob Nordby says:

    hmmm…well. I don’t wish the anguish of the residential meltdown on any other sector, but don’t be so sure that the warnings are just cliches, my friend.

    I walked right through the middle of the fire on the residential side and there were many voices such as yours still claiming that “things are going to be challenging, but are still going to be fine…” right before deep-fried hell descended upon us.

    Again, I don’t relish the prospect of something similar in commercial RE and I hope that some of your positive factors (slightly more conservative lending practices, etc.) weigh in strongly.

    On the other hand, it’s too early to tell, in my opinion.

    I hope more people have their powder dry!