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The Commercial Real Estate Bubble

36 Pages Posted: 16 Feb 2012 Last revised: 17 Jul 2013

Adam J. Levitin

Georgetown University Law Center

Susan M. Wachter

University of Pennsylvania - Wharton School, Department of Real Estate ; University of Pennsylvania - Finance Department

Date Written: July 15, 2013

Abstract

Two parallel real estate bubbles emerged in the United States between 2004 and 2008, one in residential real estate, the other in commercial real estate. The residential real estate bubble has received a great deal of popular, scholarly, and policy attention. The commercial real estate bubble, in contrast, has largely been ignored.

This Article shows that the commercial real estate price bubble was accompanied by a change in the source of commercial real estate financing. Starting around 1998, securitization became an increasingly significant part of commercial real estate financing. The commercial mortgage securitization market underwent a major shift in 2004, however, as the traditional buyers of subordinated commercial real estate debt were outbid by collateralized debt obligations (CDOs). Savvy, sophisticated, experienced commercial mortgage securitization investors were replaced by investors who merely wanted “product” to securitize. The result was a decline in underwriting standards in commercial mortgage backed securities (CMBS).

The commercial real estate bubble holds important lessons for understanding the residential real estate bubble. Unlike the residential market, there is almost no government involvement in commercial real estate. The existence of the parallel commercial real estate bubble presents a strong challenge to explanations of the residential bubble that focus on government affordable housing policy, the Community Reinvestment Act, and the role of Fannie Mae and Freddie Mac.

Keywords: commercial real estate, CMBS, CDO, bubble, securitization, B-piece, Basel, rating agencies, capital requirements, residential real estate, housing, REMIC

JEL Classification: K2, K11, M2, E30, G00

Suggested Citation

Levitin, Adam J. and Wachter, Susan M., The Commercial Real Estate Bubble (July 15, 2013). Georgetown Law and Economics Research Paper No. 12-005; Harvard Business Law Review, Vol. 3, pp. 83-118 (2013); Georgetown Law and Economics Research Paper No. 12-005; Georgetown Public Law Research Paper No. 12-018. Available at SSRN: https://ssrn.com/abstract=1978264 or http://dx.doi.org/10.2139/ssrn.1978264

Adam Levitin (Contact Author)

Georgetown University Law Center ( email )

600 New Jersey Avenue, NW
Washington, DC 20001
United States

Susan Wachter

University of Pennsylvania - Wharton School, Department of Real Estate ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104-6330
United States
215-898-6355 (Phone)

HOME PAGE: http://real.wharton.upenn.edu/~wachter/index.html

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

HOME PAGE: http://real.wharton.upenn.edu/~wachter/index.html

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