Is Commercial Real Estate The Next Subprime?

Mounting evidence suggests bubble conditions may be emerging in US commercial real estate valuations, CreditSights warns in a new report on the sector.

The recent boom in non-residential construction has almost entirely made up for the slump in residential investment, in turn significantly increasing the economy’s dependence on the commercial real estate sector, CreditSights says in Bubblenomics - Hunting for the Next Subprime in Commercial Real Estate. An even bigger problem may be overinflated commercial real estate prices, the report says.

The commercial real estate sector does not appear to be as bubbly as it was in the mid-1980s, but a slowdown in non-residential investment at a time when residential investment is already in the dumps could have serious consequences.

With the carnage from the housing market meltdown now largely, though perhaps not entirely, priced into the market, CreditSights says it is hunting for what other shoes might be left to drop. “In this vein, we remain concerned about the prospects for Collateralized Debt Obligations of Asset-Backed Securities, which so far have managed to avoid the same kind of downgrade wave that has hit much of the subprime RMBS sector. Most CDOs of ABS are, by nature, diversified outside of subprime RMBS, so it only makes sense that these CDOs have been able to avoid similar downgrades so long as ABS products outside of RMBS have managed to avoid the problems of subprime.”

But the ability of CDOs of ABS to avoid widespread downgrades can only hold up if the other ABS sectors manage to avoid correlation spillovers from subprime Residential Mortgage-Backed Securities. With a few exceptions, most non-RMBS ABS sectors have until now been able to avoid much in the way of subprime contagion.

Commercial MBS, and CDOs of commercial real estate loans, have been notably quiet in terms of downgrades, especially compared to subprime RMBS, CreditSights notes.

The creeping signs of bubble conditions in the commercial real estate market, however, raise the specter of a potential unwind of the CMBS market similar to what has been going on in the RMBS market.

The full report Bubblenomics - Hunting for the Next Subprime in Commercial Real Estate is available for purchase.

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Technorati Tags: CDO, commercial real estate, Real Estate, structured finance, subprime mortgage
Wednesday, October 10th, 2007 : Credit Research : 5 Comments

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