This paper discusses the premature pricing-in of commercial real estate distress, particularly up the capital structure. Spreads on higher-rated CMBS classes have reflected loss expectations comparable with or beyond those seen in the commercial real estate recession in the late 1980s/early 1990s. However, the authors find that underlying commercial real estate fundamentals remain firm and comparisons with subprime are overstated. They conclude that despite downside risks to recent vintage collateral from a weakening economy, it is too early to price in such a level of base-case losses. The prolonged period of CMBS spread compression came to a dramatic end in 2007, as spreads widened and the credit curve steepened. However, underlying commercial real estate fundamentals largely were steady, and delinquencies stayed in check, with some signs of weakness in recent-vintage collateral, especially in multifamily. The gradual decline in property values is expected to continue given the repricing of debt and the effect of decelerating economic growth on rent projections.
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