Lending ‘Bubble’?: Interview with Sam Chandan

Chandan Economics’ stress test of 3,900 originated mortgages recently showed “the credit risk of new apartment mortgages weakened over the course of 2012.” Sam Chandan, chief economist, spoke with CPE finance editor Keat Foong about the magnitude of the lending risks and suggested that low-cost financing, rather than excess liquidity, is causing the increases in property valuations.

Is the availability of debt capital driving a property bubble in commercial real estate?

Low-cost financing is allowing investors to compete more aggressively for acquisitions, in the apartment sector and for core office assets in particular. That is exerting upward pressure on prices that must be offset by sustained income growth. In some cases, income will not keep pace with rising yields and prices will adjust. The weight of that adjustment will bear on investors, who have become increasingly less selective in executing on their acquisition strategies.

Is there currently a lending bubble in some of the top markets?

Our credit risk models show rising default risks that are generally back-ended to maturity or resets on adjustable financing. We run a gap analysis each quarter that captures the careful balancing act between income and borrowing costs. Of the top markets, our biggest concerns are with multi-family lending in Washington, D.C. The problems might not be apparent, since protracted interest rate distortions are a new condition. Lenders are quick to point out they are not making the same mistakes as last time. The drivers of credit risk are not the same as last time.

Which elements of lending may have become more permissive?

Some banks are competing successfully against agency lenders. That’s a competitive market where they are making loans that push the envelope furthest. It shows up in a variety of ways, including more limited amortization and substantially lower debt yields on properties that demonstrate low and moderate income growth.

CMBS has a different driver. Depending on conditions in the bond market, appetite for CMBS can grow faster than the number of high-quality financing opportunities. The conduit responds with adjustments to underwriting that broaden the pool of potential borrowers.

Are property prices supported by fundamentals in the riskiest markets?

Underwriting standards in several segments of the D.C. market do not anticipate tail risks or a general slowdown in the pace of rent growth.

For more on the lending risks, see “Bubble in the Making?” in the September 2013 issue of CPE.