Commercial real estate. The next to fall

office building
Commercial real estate will be the next domino to fall. Portfolio explains why.

Lending standards fell, starkly. Or as I prefer to see it, they were thrown out of the 60th-floor window of that gleaming office tower in downtown Atlanta/Phoenix/New York/San Francisco/insert your city here. The gap between the cost of debt servicing and the cash actually being generated by the buildings narrowed. What’s more, it used to be that banks made loans for no more than 80 percent of the value of a property to ensure a healthy cushion of protection, but by the early part of 2007, loans were sometimes made for 120 percent of a property’s value. Who would be so crazy as to lend more than a property is worth? Anyone who believes in perpetual-motion machines—that is, that rents and underlying property values must always go up.

Or someone who was making large fees for doing so and who care if loan went bad. Because the real point was to package the loans into bonds so they could be sold, thus making more money.

Regulators did nothing to stop this until the bubble burst. For those who say that markets function best when unregulated, I say, this is what happens when they are.