The case of the missing commercial real estate cycle

Booms and busts in commercial real estate have been a traditional source of distress for financial institutions.2 In the early 1990s, for example, the downward correction of commercial property prices caused a significant increase in bad debt expenses for banks and other financial institutions, and turned out to be a major contributor to the global economic downturn. In contrast, the commercial property cycle was much less pronounced in the recent global business cycle. While housing prices have risen markedly in a number of countries in the past five years, with few exceptions commercial property prices have remained well below the level reached a decade ago. This “missing” commercial real estate cycle is arguably partly attributable to the rapid growth of real estate securitisation in the past decade. First, the emergence of new financing methods provided a substitute for traditional banking finance and may have helped even out the flow of capital into the commercial property sector. Second, the development of public markets improved information transparency and may have strengthened market discipline. And finally, the development of public real estate equity and debt markets made it possible for commercial property risk to be spread through capital markets to a wider array of investors. Nevertheless, these structural changes by no means imply that commercial real estate cycles have disappeared. To a significant extent, the absence of a commercial property boom in the late 1990s could be a consequence of the slow pace of absorption of the overcapacity generated during the late 1980s boom. Furthermore, the closer integration of commercial real estate markets with capital markets does not suggest that the commercial property sector will now be immune to all shocks. In fact, commercial property markets might even be subject to new sources of market volatility.