Summary
Unlike prior downturns where economic weakness compounded with addition of recently completed property supply contributed to commercial real estate downturn, the current downturn has been fueled by excessive use of creative debt financing. The unwinding of creative leverage will take longer than previously and could delay recovery.
Analysis
In prior downturns, holders of real estate mortgage debt were generally banks or insurance companies. When loans went sour, these institutions had experience in working through troubled loans in a reasonably expedited manner.
Over the past few years CMBS was a major contributor to the increase in commercial mortgage debt and, as a byproduct, fueled price escalation. The music has clearly stopped and the holders of much of the loans that are expected to go into default will be CMBS Trusts. Rules of the road for workout within the CMBS market are being formed as we speak. A fair amount of ambiguity exists in CMBS documents which will ultimately contribute to delays, increased legal costs, and potentially greater losses than otherwise.
While this downturn certainly contains some similarities to prior downturns - severe recession, weak property user demand, the complexity surrounding financing over the past few years is a meaningful distinction which could contribute to slower recovery vs. prior cycles. Put simply, the mechanism for clearing the debt markets of underperformers has not yet been created,
