Prepare for a Commercial Real Estate Finance Disruption

An inside look at what’s in store by CCIM Institute’s Chief Economist.

Debt capital has grown exponentially over the past seven decades. Technology is expanding just as quickly, if not more so. The U.S. economy is in the late stages of a decade-long recovery, while technology is early in a cycle of innovation that is altering the design and use of commercial real estate. On top of that, commercial real estate professionals too often are afflicted by a belief that trends and patterns today will continue, a phenomenon known as recency bias.

If history has taught us anything, it's that these patterns of recovery and expansion are prone to disruption. With the midterm elections upon us, as well as recent tariffs on $200-plus billion of Chinese imported goods -- not to mention the third interest rate hike in 2018 by the Federal Reserve -- the country is re-entering a period of volatility and uncertainty.

The question of the next CRE finance disruption is not a matter of when, but how. Housing might be the first thing that comes to mind, but you'd be wrong.

Inevitable Disruption

Real estate is not immune from business cycles, economic recessions, or disruptive “Black Swan” events -- such as a trade war, currency crisis, or cyber terrorism. In fact, the probability of a CRE finance disruption in the next 6-18 months is as elevated as it was prior to 2007-2008. The lineup of suspects this time around include the repeat offender of rising interest rates, a concentration risk the likes of which we've never seen, and the Fed's exiting of quantitative easing. The sunsetting of London Interbank Offered Rate (LIBOR), the Current Expected Credit Loss (CECL) model for banks, and changes in lease accounting are all likely accomplices. 

The one-two punch of the Fed's rate hikes and recent efforts to move away from quantitative easing is a particularly powerful one. All the securities purchased during the quantitative easing period following the latest financial crisis are now being sold back into the market. And by doing so, the Fed is reinjecting risk premiums into the system -- precisely what is not needed at this time. 

Moreover, history is not on our side. Recessions have become less frequent, but more severe. The adverse effects from these less-frequent-but-more-severe economic disruptions is a more severe impact and value volatility in CREF -- cases in point are the S&L crisis of the late 1980s and most recently the 2008-2009 financial crisis.

Now is not the time for complacency. The industry is sure to persevere once again. But to survive and flourish during troubled times, knowledge -- and adaptability -- is power.

This is a modified excerpt from CCIM Institute's 4Q18 Commercial Real Estate Insights report.

Read the 4Q18 Report

Media inquiries: Contact Larry Guthrie, Director of Communications, at lguthrie@ccim.com or (312) 321-4535.

K.C. Conway, CCIM, MAI, CRE

K.C. Conway, CCIM, MAI, CRE, is CCIM Institute's chief economist. 

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