The Two Sides of the Coming Liquidity Crisis

The mortgage market has always been an integral part of the United States commercial real estate market. Other than US pension funds, there have been very few all-cash buyers in the market during the past forty or fifty years. Estimates prepared by JP Morgan indicate that there is approximately $3.5 trillion of real estate debt currently outstanding, representing just over 50% of the value of the total US commercial real estate market. In a presentation before the Joint Economic Committee of the US Congress, the Real Estate Roundtable stated that the three largest providers of real estate credit are commercial banks, with $1.5 trillion, or 43%; commercial mortgage backed securities (CMBS) with approximately $750 billion, or 22%; and life insurance companies, with $315 billion or 9%. Since commercial banks are not currently making mortgage loans, and since the CMBS market has simply disappeared, it seems clear that the normal mortgage market will be unable to meet the demand for real estate credit in the foreseeable future. Existing real estate owners with maturing mortgages will face difficult decisions as to how to refinance, while new investors, with strong cash positions, will have the opportunity to buy quality properties at discount prices.

The Lack of Mortgage Lending

The potential crisis facing the commercial real estate market arises from the fact that, with the possible exception of life insurance companies, the principal sources of mortgage debt are not active in the market today. The actions of the Government and the Federal Reserve have apparently prevented a major financial catastrophe, and the liquidity of the banking system has in large measure been restored. But as we move into the Fall of 2009 the banks have not yet begun to resume their role as the principal source of mortgages for the commercial real estate market. With the recession continuing and the resultant negative outlook for the commercial market, they prefer not to take on any new risks while the old “toxic assets” are still on their books.

The reason that mortgages are not available in the CMBS market is, in a way, easier to understand since that market completely disappeared after the financial crisis hit. Unfortunately, the commercial market was tarred with all of the excesses that had been rampant in the residential mortgage market. Investors around the world had purchased investments that rested upon sub-prime residential mortgages that had been rated “AAA” by the rating agencies. When the recession hit and residential mortgage defaults soared, these investments, many of which had themselves been leveraged to the extreme, quickly began to fail. Nothing comparable has occurred in the commercial market, where the fundamentals have remained relatively positive. But the sale of commercial mortgage backed securities became impossible after the recession began, and the banks and investment houses effectively closed down their CMBS units, thereby shutting off what had been one of the major sources of commercial mortgages.

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