Goldman's Call: CRE is Next

I have been speculating for some time that commercial real estate might be the next US asset class to take a hit. In fact I first wrote about this issue in May of 2007 in a post titled "Froth in Commercial Real Estate." We've been seeing turmoil in that marketplace for quite some time, but it looks like 2008 might be the first major leg down. Obviously any pronounced downturn will hurt businesses and commercial real estate. But, the longer and more pronounced the recession, the worse CRE could get.


Of all the Wall Street firms, Goldman has been perhaps the best at identifying major structural issues in the US economy over the past 2 years. They hedged against subprime better than any other firm, they have been correctly bullish on agricultural commodities, they saw the major bank writedowns coming and now they are calling for a major (20%+) CRE correction.

You can read the full article here. Or you can just read this ubiq-cerpt:

After suffering a beating from their exposure to home loans, banks and securities firms are about to take their lumps from office towers, hotels and other commercial real estate. And the losses could last longer than those from the subprime shakeout.

As the economy wobbles and financing costs rise because of the credit crunch, commercial-real-estate values are starting to slide, with analysts at Goldman Sachs Group Inc. projecting a decline of 21% to 26% in the next two years. That means misery for securities firms with exposure to commercial-real-estate loans and commercial- mortgage-backed securities.

William Tanona, a Goldman analyst, expects total write-downs of $7.2 billion by Bear Stearns Cos., Citigroup Inc., J.P. Morgan Chase & Co., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Morgan Stanley in the first quarter. Those firms had combined commercial-real-estate exposure of $141 billion at the end of the fourth quarter.

Goldman analysts predicts the financial damage from commercial real estate could last as long as two years, which would mean "a significantly longer tail than subprime." That is because only 28% of commercial-real-estate loans have been packaged into securities since 1995, while about 80% of subprime loans have been securitized; the higher level of securitization subjects the subprime assets to more-immediate mark-to-market accounting, which is playing out in the form of the write-downs that are dominating headlines.

I hate to say this, but I hope Goldman is wrong about the long tail effects of the CRE slodown. Hopefully the decline will be swift so that we can start putting this major real estate asset bubble behind us. For more on this issue check out this CNBC video.

In one final note I want to draw attention to the Markit CMBX indices. The particular index of note is the one that I first posted about back in July of 2008. At that point the CMBXNA-BB 3 index had a spread of 600 bps. As of today that same index has a spread of nearly 2000 bps:
Hat Tip: WSJ