Commercial Lending in Real Estate – An Economist’s View

I can’t help to notice the many trade journal articles published over the last several months covering the dramatic shift of industry asset allocations from commercial and industrial loans (C&I) to commercial real estate loans. This long-term transition to Commercial Real Estate (CRE) has continued to accelerate over the last 30 or so years and is beginning to gain the attention of the industry, including regulators and skeptical economists.

Alex Pollock, a Distinguished Senior Fellow at the R Street Institute in Washington, DC, recently published an article in American Banker asserting that the biggest change in banking over the last 60 years is this shift to real estate finance. Such a dramatic shift, of course, presents risk implications for the entire banking system.

Pollock points out that real estate concentration is particularly evident among the nation’s smaller banks (assets < $1 billion). Of the roughly 5,000 US banks with less than $1 billion in assets, real estate loans make up 75% of the total loans, collectively. To add to the concern of smaller banks currently being at higher risk, it’s important to note that over 80% of commercial bank failures that occurred from 2007 through 2012 consisted of banks which operated, prior to failure, with real estate loan ratios in the top half of the industry.

In a recent The Wall Street Journal article, Eric Rosengren, a voting member of the rate-setting Federal Open Market Committee, voiced his concern about the latest round of growth in the CRE sector, which has been bolstered in part by historic low interest rates and a crop of investors seeking higher-yielding returns.

So what is your opinion about commercial real estate?  My next post will include more thoughts from the CRE view point of the regulators.

Note: This post is part of Construction Lending 101: The Ultimate Guide to Modern Construction Loan Management.

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