The Commercial Real Estate Bubble
Adam J. Levitin
Georgetown University Law Center
Susan M. Wachter
University of Pennsylvania - Wharton School, Department of Real Estate
July 15, 2013
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
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.
Number of Pages in PDF File: 36
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
Date posted: February 16, 2012 ; Last revised: July 17, 2013