Friday, January 8, 2010

Are Commercial And Residential Real Estate Collapses Related?

There are more boom and bust cycles in commercial real estate (certainly on a regional level) than residential. Bank CRE lending went bust in the mid to late 1970s (money center banks had severe commercial real estate loan problems then), the late 1980s (Bank of New England among others had tremendous problems) through early 1990s (purported reason for Chase-Chemical Bank merger) and now.

Residential housing did not go through the same severe post WWII boom/bust cycle until now. The S&L collapse of the 1980s was due mostly to a mismatch in funding. Using short-term rates to fund long term fixed mortgages and when short-term rates rose, legacy fixed rate mortgages on the S&L books produced losses instead of profits. There was not a similar housing price collapse or excessive residential mortgage defaults that caused the S&L problems.

It would be astounding in this economic downturn if CRE did not show a severe downturn. Commercial real estate developers seem to always overbuild in good times, suffer huge losses in bad economic times and take the banks with them. Their philosophy is if you build it they will come and I will build it if you give me the loan until banks stop lending to them, call in the debt, and they file for bankruptcy or restructure their debt.

CRE difficulties are on a distinct cycle that follows the ups and downs of the economy. The cycle is separate from residential and just happens to overlap this residential housing crisis.

I think the fundamental question is if the economy had not gone into a recession would the housing market have collapsed any way? If it were in a bubble then it did not need a recession to burst and housing would have crashed anyway. Maybe it would collapse later than it did, but it was inevitable.

If the early effects of the recession started and caused the housing collapse (lower productivity, increased unemployment, lower HH income, lower than expected growth in HH income, higher oil prices) then the recession is the prime mover. There may have been feedback and amplification from the concurrent housing collapse, which made the recession worse. In this scenario, the housing bubble is a side issue to the recession causes and is only an issue for why it was not contained and limited in its effect.

We could just be in the unfortunate situation of having two bad economic things occurring at the same time. A housing bubble burst and a recession. In which case, more work needs to be done on the cause of the recession, why it became so severe and on what the Fed missed that allowed the recession to happen. That is a different focus that preventing future bubbles.

There has not been a coherent and clear understanding of why the housing collapse caused such a severe recession (certainly in employment and consumer demand). A homeowner that defaults or walks away from a mortgage, frees up the excess amount of the monthly payment over renting, a lower priced home, or moving in with someone else and consumer demand should not decrease. Even those that foresaw the bubble collapse never expected the economy to collapse as much as it did.

I think we are dealing with two different issues that just happened at the same time. Something akin to a flood and a war, both horrible if they happen at the same time, but neither causes the other. The housing bubble burst and something else caused severe unemployment, a consumer demand collapse and a recession.
The above is a comment I posted to Arnold Kling's post, "Commercial Real Estate Prices: What Inference to Draw?" on EconLog.


  1. There is no suprise. It's part of the doom and gloom in the market. Even here in singapore, there are year where HDB flats are favorable to the seller and there are times it's favorable to the buyers. In conclusion however, real estate has a vital role in every country's economy especially when inflation rate is concern.

  2. We can't stand on both but let's see how the property market can recover so far. In the past few months especialy in the first quarter of this year, the market slightly collapse. Here in singapore we felt the huge effect at around december of last year. As far as i know, the buying market has been turning in at its lowest. But If I were to be asked, the best property today still belongs to the singaporean people.

  3. I don't think so but based on your article, there is a great chance now that real estate market could suffer. Here in singapore, we're forecasting the fluctuations and some real estate agents are jump shipping to other careers although there are still those who took advantage of the doom and hence generating massive sales via their referral networks.