Fisher Center for Real Estate and Urban Economics

Commercial real estate (CRE) has undergone enormous changes over the past two decades, even apart from the financial crisis. At the end of 2011, commercial and multifamily mortgage balances totaled over $3 trillion. That was about twice as much at the end of 2000. At its peak in 2008, the ratio of balances to the size of the U.S. economy was one and a half times as large as in 2000. Since 2007, several indicators signaled that commercial mortgage underwriting, after apparently being lax, had tightened rapidly and severely. Historically, more than half of commercial mortgages were held by commercial banks and other depositories. Life insurers historically were the other major holders. Over the past dozen years, however, securitized pools have held increasingly important shares of total commercial mortgages. Thus, the relative size of the commercial mortgage market has fluctuated considerably and the percentages of total commercial mortgages that different groups of investors held have also shifted considerably over time. In addition, (inflation-adjusted) CRE prices dipped by more than 20 percent in the early 1990s, before rising about 50 percent during the 2000s and then dropping by about 40 percent during 2007-2009.We develop an index of commercial mortgage underwriting that combines information for 1990-2011 from the three largest segments of originators of these mortgages: depositories, life insurers, and issuers of commercial mortgage-backed securities (via conduit and other lenders). For depositories, we used surveys about commercial mortgage underwriting conditions from their loan officers and government-employed examiners. For life insurers, we used indicators of key elements in commercial mortgage underwriting: capitalization rates and yield spreads. For CMBS, we used interest spreads for their mortgages and for their AAA securities. We also explain why loan-to-value ratios were unlikely to accurately reflect underwriting during 1990-2011.We then used the index in a vector autoregression to estimate how CRE price growth and commercial mortgage flows responded to changes in underwriting, and, in turn, how price growth and mortgage flows affected underwriting itself. We found that underwriting had important, independent effects on the CRE market.We also found that underwriting loosened when (the growth rates of) CRE prices rose. Our results suggested that, before the crisis, underwriting responded to recent, past prices. That implies that underwriting amplified movements in CRE markets: Faster price growth loosened underwriting, which raised CRE lending and prices, which in turn loosened underwriting further. The crisis apparently changed how commercial mortgages were underwritten. While past prices continue to directly affected it, underwriting also became significantly affected by predictions of future developments in CRE prices.