Spring 2017 markets experienced a rise in securitization as well as deregulation. In response, large banking institutions increased their credit exposure to real estate markets, and commercial real estate in particular (Zarutskie, 2013). Commercial mortgage-backed securities (CMBS) were the primary vehicle for private securitization of commercial real estate credit instruments (Antoniades, 2016). However, this shift in financing for commercial real estate created substantial consequences for global financial stability.Securitization of commercial real estate financing was accompanied by rapid price appreciation of commercial real estate assets beyond fundamentals in the period preceding the GFC (Levitin and Wachter, 2013). Although the GFC was largely blamed solely on the housing finance system in the United States, the role of commercial real estate raises important questions about the similarities and differences between the markets for residential and commercial real estate credit. Both markets are significant due
to their relative size (although the market for residential real estate credit is much larger than the market for commercial real estate credit). In addition, as both commercial and residential real estate are ‘leveraged assets,’ their heavy reliance on debt financing inextricably links them to the financial system. This link is made more intricate by the complexity of the underlying assets. Although microeconomic analysis of borrower decision making in residential real estate credit is relatively simple, commercial real estate credit presents far more complexity. Analysis of borrower decision making in commercial real estate is complicated by the sheer number of entities involved. Relative to residential real estate, “where a property most often has one equity player (the mortgage holder) and one debt player (the mortgage bank), commercial real estate properties are often financed by multiple debt and equity players” (Steering and Advisory Committee — Asset Price Dynamics Initiative, 2016, p. 23). The structure of commercial real
Columbia Economics Review
55 estate credit instruments themselves also contributes to complexity. This is demonstrated, in part, by the nature of defaults on these instruments. In contrast to “residential defaults that result from failure to maintain monthly mortgage payments, commercial real estate defaults are most often ‘maturity defaults’ in which the borrower is unable to borrow a large enough sum to pay off an expiring loan. The difference between the balloon payment owed on the maturing loan and the amount that can be borrowed today is the ‘equity gap.’ The equity gap is caused by two factors: falling valuations of commercial real estate and lack of liquidity” (Marsh, 2011, p. 35). Default structure presents evidence of considerable risk that is due, in part, to the perspective of credit providers in commercial real estate. The systemic significance of the market for commercial real estate credit is further fueled by the increasing interconnectedness of global credit markets (upon which commercial real estate relies for financ-
Published on May 15, 2017
Published on May 15, 2017
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