Is Commercial Real Estate Following Residential Over the Cliff?

When you combine naivety, greed and inexperience with the responsibility of controlling large amounts of money, you have a formula for financial pain. Those are the characteristics that caused the subprime mortgage crisis and those are the same characteristics that are now apparent in the commercial real estate estate market. Consequently, there are signs of weakness in the immediate future for the value of commercial real estate. Weakness in commercial real estate is the breeding ground for concessions.

During the past twelve months, the top ten financial institutions purchased for their own account or a managed account over $190 billion of commercial real estate. This compares to the recent annual sales volume for existing homes of over six billion and for new homes of over one billion. The sheer volume of commercial real estate buying by these ten institutions preempts the possibility of comprehensive due diligence. Likewise, the sheer volume of new mortgages that were placed on existing and new homes stymied competent appraisals. In each case, the person involved lived by the same credo. Buy it or lend to it, and it will go up. They both epitomized naivety.

In both cases, the persons involved in the buying of commercial real estate and the persons involved in creating new mortgages made more money from more volume. They both epitomized greed.

Finally, the persons involved in the buying of commercial real estate and the persons involved in creating new mortgages lacked experience. The majority of people involved never lived through a recession. Many believed there will be no more recessions and acted accordingly.

The headline on the front page of the Wall Street Journal dated March 8 - 9 2008 read: "Jobs Data Suggest U.S. Is in Recession". The Wall Street Journal article is based on rumor, innuendo and selected quotes. Looking at the last 100 years of business cycles, one could have come to the same conclusion as early as December of 2007. Historical data will always trump static analysis. The activities in commercial real estate should be viewed through this same historical lens.