Bloomberg

Commercial Property Prices Surpassed Prerecession Levels Doesn’t Mean Crash Inevitable

U.S. commercial real estate prices have reached new highs, but the sector is a much safer place today than it was before the 2008 financial crisis.

Low capitalization rates—the net operating income a property generates relative to its price—might normally keep investors away, but low borrowing costs have made potential returns from commercial real estate attractive.

Lenders, for their part, are avoiding many of the risky practices that contributed to the last real estate crash. Thanks to pressure from the Federal Reserve and government regulators, banks have been tightening their commercial real estate lending standards.

Banks have picked up the lending slack caused by a less robust market for commercial mortgage-backed securities. But bank lending largely involves mortgages for existing properties rather than riskier loans for new construction. Banks’ conservatism has made it more difficult for developers to fund new construction, which in turn has prevented many markets from being overbuilt.

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Mortgages themselves are more conservative as well, with banks lending against a smaller portion of a property’s value. Lenders are also requiring borrowers to keep more cash on hand to pay off debts, improving banks’ odds of getting repaid.

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None of this means there won’t be pain if real estate prices suddenly crash. No amount of structural padding can insulate lenders from a nasty downturn.

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There are also lots of players in the market who have looser lending standards and may face even more pain than banks should a downturn come. As my Bloomberg colleagues Sarah Mulholland and Heather Perlberg have pointed out, shadow lenders, including private equity firms like Blackstone and Starwood, as well as online crowd-funding sites, are all taking on loans that banks have decided to forego.

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Source: Crain’s Chicago Business October 11 ,2016 Rani Molla
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