Every one of you likely remembers where you were at the end of 2007 when the cracks in the real estate financial system started spreading to the larger economy. It started in November when Bear Stearns reported their first quarterly loss in the company’s history. At the time, most of the world thought that these cracks were just superficial and attempted to fill them with additional capital. The Chinese sovereign wealth fund injected Bear Sterns with a new investment. But, by the spring of 2008 it was evident that this was more like spreading some new mortar over the problem rather than fixing the foundational problems causing it.
The result brought the world’s financial system to its knees. The U.S. alone shed nearly 9 million jobs during 2008 and 2009, roughly 6 percent of the workforce. U.S. household net worth declined by nearly $13 trillion (20 percent!) from its pre-crisis peak in the second quarter of 2007and U.S. housing prices fell nearly 30 percent on average and the U.S. stock market fell approximately 50 percent by early 2009.
There were many reasons for this but one of the main ones was that American mortgage portfolios were divided and sold in such a way that it was nearly impossible to fully understand their underlying risk. This process was called mortgage backed securitization and, while it has been reigned in since the recovery, is still a large piece of our investment landscapes.
“The great recession,” as it was called, was triggered by residential mortgages and so the bulk of the regulation was aimed at that side of the mortgage industry. But, commercial real estate also has its own mortgage industry. While not as big as its residential counterpart, these still pose a risk to the banks and investors that hold them. And that risk, as we are starting to find out, might be higher than previously thought.
Yesterday one of the the premier databases for commercial real estate finance released a report that the generally accepted number for the size of the commercial real estate market, the one reported by the Mortgage Bankers Association, might be much lower than the actual amount. The MBA’s most recent announcements claim that around $574 billion new commercial real estate loans were generated in 2018 whereas CrediFi reportedly tracked more than $925 billion.
Jamie Woodwell, the MBA’s vice president acknowledges that his organization and CrediFi are “measuring different things.” He says the MBA tracks the financing of “income-producing” properties, those leased from one party to another, while ommiting data on “owner-occupied real estate,” while these are factored into the CrediFi report.
Even with the difference in methodology, the numbers are a bit of an eye-opener. The CrediFi report warns that a downturn for the commercial property industry might be coming soon as it has seen “a 4% overall slowdown in CRE from 2017-2018.” It warns that this extra, previously unreported exposure might put the economy at risk of repeating what happened in 2008. “Banks are not diversifying their risks off of their books as they once were,” the report claims, which is exactly the kind of thing you don’t want to hear if we are going into the downturn that everyone seems to think is around the corner.
This is the first formation of a crack in the commercial real estate industry. Whether these are a symptom of a larger structural problem we won’t know but I thank CrediFi for at least brining it to our attention rather than painting over it and pretending that everything is fine.