CRE’s Risk (or Not) to the Financial System

Several factors could trigger the next recession, but it’s unlikely a sharp downturn in commercial real estate will be the cause, said Wells Fargo Securities, Charlotte, N.C.

In a report, Does CRE Pose a Risk to the Financial System?, Wells Fargo Global Economist Jay Bryson, Economist Charlie Dougherty and Economic Analyst Matthew Honnold acknowledged that an observer could become unsettled about the “incredible” amount of CRE construction activity and property prices. “After all, it was overbuilding in the nation’s housing market that nearly imploded the financial system a decade ago,” the report said. “Older readers will remember the overbuilding in commercial real estate in the 1980s that led to the demise of multiple savings and loan institutions and contributed to the recession of 1990-1991.”

Wells Fargo noted depository institutions currently own $1.7 trillion of commercial mortgages, nearly 60 percent of total commercial mortgages outstanding. “At first blush, it appears that banks could be overly exposed to commercial mortgages today,” the report said. “But the absolute exposure of American banks to commercial mortgages at present is not nearly as high as their exposure was to residential mortgages a decade ago.”

In early 2008 banks held $3.4 trillion in residential mortgages and also had indirect exposure through owning more than $1 trillion in residential mortgage-backed securities. So, bank exposure to the residential real estate market just before the Global Financial Crisis far exceeded their $1.7 trillion exposure to commercial real estate mortgages today, Wells Fargo said.

“In short, it does not appear that American banks are overly exposed to commercial property, either absolutely or relatively,” the report said. “In addition, the exposure of American banks to commercial real estate is not out of line in a historical context.”

The authors said American banks could suffer significant losses if the commercial property market experienced a significant downturn but said commercial real estate fundamentals appear fairly solid at the moment.

“With memories of the housing market implosion still fresh in many minds, it is natural to wonder if a bubble is developing in the commercial property market,” the report said. “Despite the appearance of strong construction activity, we are not overly concerned about the commercial property market at this time.”