U.S. Credit Downgrade and Commercial Real Estate

It's been hard to escape the talk of downgraded U.S. debt, though if you have any interest in the country as a whole it's hard to imagine why you'd intentionally avoid it. That is not to say, however, that I'm taking a hard-lined doomsayer view; rather it's simply too novel of an event to ignore–especially in light of the ripple effect it may cause. What type of ripple effect(s)? Well, considering this blog focuses on commercial real estate, it shouldn't be surprising that my discussion centers on commercial real estate. And over at Investor's Business Daily, Bloomberg, and RetailTraffic, some light was shed on the issue.

Common to all three articles was the growing sense that whatever momentum we've experienced over the last quarter–and indeed there has been impressive growth–is at risk of being lost. Unfortunately, the reasons which are cited while interconnected, are ill-defined, making a proper remedy difficult to prescribe. For example, the idea of “uncertainty” is the oft cited culprit. Surely, this is a legitimate cause and I agree with David Bodamer of RetailTraffic when he explains that,

Corporations that opt to sit on cash rather than invest or to hire and consumers that opt to save rather than spend will slow demand within the commercial real estate sector.

Practically speaking, this translates into delayed leasing activity and building expansion at the company level. In theory then, we should expect downward pressure on the office and retail markets–which is exactly what happened.

Top-ranked commercial mortgage-backed securities yielded about 298 basis points, or 2.98 percentage points, more than Treasuries as of yesterday, according to a Barclays Plc index. The yield was last that high in July 2010. The spread jumped 35 basis points last week and is up 89 basis points since the end of the second quarter

Narrowing spreads are generally indicative of a positive lending environment (the cost of capital/hedge risk for originators is reduced), whereas widening spreads tend to represent the opposite. So according to these authors (and the sources they cite), uncertainty leads to instability which leads to tightened capital markets which in turn, creates more uncertainty? Got it. Except, isn't this circular reasoning? After all, when used in this context, “uncertainty” doesn't have much explanatory power. What exactly is the source of uncertainty: is it the Dodd-Frank Act, concern over Europe's economy, the Tea Party, Congressional gridlock, Obamacare, etc., etc.? To me, it seems as if we're dancing around the issue(s). If however, we're interested in seeing a healthy commercial real estate market, maybe its time to start the asking the difficult questions.