The lesson that was learned (or re-learned) in the commercial real estate (CRE) crash of the early 1990s was that problems associated with massive over-supply can plague the industry for many years. The lesson that will be learned in the current crash (with CRE prices declining by 40-50%, or more, from their peaks, the term crash is, once again, appropriate) is that problems emanating from the financing side—in particular, a massive deterioration in underwriting standards and a concurrent rise of excessive leverage—can lead to problems of a similar (or greater) magnitude, even without supply problems.
While most attention in commercial real estate today is focused on the dramatic deterioration in term loan performance (i.e. the performance of loans prior to maturity), we believe that a potentially even more troublesome issue is the extent to which loans originated during the
2005-2007 period will encounter problems refinancing at maturity. To date, this issue has largely been dismissed with the vague and, in our view, naive observation that lenders will simply extend the maturity dates of loans that fail to qualify for refinancing. However, the scale of this problem is virtually unprecedented in commercial real estate, and its impact is likely to dominate the industry for the better part a decade.
At its core, the issue is fairly straightforward: The dramatic weakening in underwriting quality that began in 2005, along with compressing cap rates and ballooning leverage, led to rapidly rising commercial real estate prices. In 2007 the commercial real estate bubble burst, along with most other credit bubbles. Since that time underwriting standards have tightened back to their original levels, and perhaps further, as allowable leverage has plummeted and cap rates have skyrocketed. Purely as a result of the enormous changes in the available financing