Spring 2008 Vol. 33, No. 1
Abstract: In this updated article (originally published in Real Estate Issues, Summer 2003), the author suggests that in recent years, the CMBS markets created a “hustle and flow” income property loan production environment that encouraged aggressive loan underwriting standards and helped to inflate valuations of income properties—all of this leading to significant risk of income-property defaults. An analysis of CMBS loan portfolio compositions and leverage trends by the author shows there is subprime debt in the CMBS markets that has a high risk of defaulting. The rise in CMBS loan defaults, together with a tightening of CRE loan underwriting standards and the possibility of recession, may also increase deflation risk on income-property values. Commercial banks will not be immune to this potential deflation contagion, concludes the author, since many were eager to compete with CMBS, lowered their loan underwriting standards, and accepted higher property valuations to originate new loans. As a result, commercial banks will likely require tighter loan underwriting and higher risk-adjusted interest rates, which will reduce expected investment return yields for CRE property investors.