Commercial Real Estate to Remain Strong

by Jim Randel
 

There's been a lot of talk in the media these days that the next shoe to drop in the credit crisis/financial meltdown will be commercial real estate. Two weeks ago there were a couple of moderately-sized defaults on mortgage loans (hotel and retail projects) that were packaged in commercial mortgage backed securities (CMBS). The media seized on this and started worrying out loud about commercial real estate.

Let me cut through the silliness and give you "the skinny":

A bad economy will cause increased defaults in commercial real estate but nothing even approaching what happened in the residential world. Here is why:

1. Commercial real estate investors do not buy on emotion. It is all numbers. If a deal does not pencil out, it is not purchased. This does not mean that investors never make mistakes. We do (I have made many). But, it is because our assumptions are wrong or events cause changes in the projected numbers. To be contrasted are buyers of homes who fall in love with a home and then buy at whatever price it takes. An emotionally-charged purchase causes people to buy beyond reasonable values and, their means.

2. Commercial real estate lenders have not engaged in the nutty lending behavior that residential lenders did. Although there were some aggressive loans made, the magnitude of the lending mania was nothing like what happened in residential. During the last decade the world clamored for residential mortgage securities because everyone was quite convinced that U.S. housing prices never fall, and that homeowners never walk from their homes. OOPS.

3. Unique to most of the world, in the United States homeowners can generally walk from their mortgage debt without consequence. Whether you agree with this or not, it is fact. Such is not the case in the commercial world. Whenever there is personal recourse or some other kind of guarantee, a U.S. commercial mortgage lender is going to come after the commercial real estate owner should he or she up and walk from a losing deal. That tends to keep people focused and much less likely to default.

4. Most commercial real estate investors have reserves for difficult times. Even assuming that an investor could get a loan of 90%+ of value (which is much less likely than in the residential world), it would be the rare investor who had no savings or back-up for the down time. Large numbers of homeowners, on the other hand, operating under the premise that housing prices always go up, were "all in," that is they put every dime they had into buying a home.

For these and other reasons, I do not believe we will see levels of defaults in commercial real estate approaching U.S. homeowner levels (now exceeding 10%). And I wish the media would stop writing about commercial real estate defaults because it spooks lenders and investors. I will whine about this next time I am on TV.

Jim Randel is an attorney, a graduate of Columbia Law School.

For twenty-five years he made his living as a real estate investor, buying and selling single-family homes, apartment buildings, land, shopping centers, office buildings, factories and warehouses.

In 1986 Randel wrote "The Real Estate Game (And How to Win It)" which led to guest lectures at Harvard and NYU Business Schools, the National Association of Realtors Annual Convention, and numerous other venues around the United States.

For 2 years beginning in 1988 Randel was the on-air correspondent for the Financial News Television Network (now owned by CNBC) and won an award for "The Best Consumer Report" presented by the Real Estate Educators Association.