Friday, February 8, 2008

Commercial RE Lending Risk Soaring

Credit risk for commercial real estate loans has been soaring recently. Yesterday rate spreads for every single series in Markit's CMBX index (there are 27) rose to new all-time highs. Even the AAA tranches have now reached 200+ bp (2%) over, coming from lows in the single digits just six months ago.

CMBX AAA Series 3

The low grade tranches (BB and BBB-) are closing in on the 2,000 bp level (i.e. 20%), while the BBB tranches - considered investment grade - are topping 1,400 bp (14%).

CMBX BBB Series 3

This is clearly the next area where significant loan writeoffs will take place in the financial community.

For the economy, these developments could not come at a worse time. Private non-residential building activity reached $350 billion last year (up 18.3% from 2006), while residential building declined to $524 billion (down 18.2% from 2006). Thus, total private building activity - residential plus non-residential - managed to drop only -6.7% versus 2006.

This explains why construction jobs remained solid in 2006 and the first months of 2007, but are now dropping fast. If commercial building slows down significantly from here, as seems likely given the financing prospects, then the overall job picture will darken even further.

Total Construction Jobs (Chart: BLS)

The last construction boom created many more jobs than before. Given the depth of the bust, I wouldn't be surprised to see around 2-2.5 million jobs lost in the sector, to bring us back to trend. The 1990-91 recession saw a loss of 16% of construction jobs; the same percentage today would result in a loss of 1.2 million jobs.


  1. A vicious circle is gathering speed. Separate developments feed each other.

    Rather scary - but maybe indicating a paradigm shift in economics from permanent growth to something new.

    I just wonder when the next Marx, Smith, Keynes appears.

  2. I'm not sure I buy the arguement that workers switched from residential to commercial construction. The skills are diffrent (ie: wood vs metal studs), and much commectial construction is handled by large outfits with OSHA trained and certified employees. Hellasious, do you buy the arguement that much of the residential construction was by undocumented labor, who were let go without a paper trail? Foreign remittances in Mexico have plummeted, indicating that workers are sending less home.

    Jason B

  3. Total spending in construction, private plus government, housing and non-housing was -2.6% for 2007 vs. 2006. I'm sure workers shifted as work became available elsewhere. For example, hotel construction spending soared 60% last year.

  4. Jason,

    I disagree and think it entirely possible that they are interchangeable.

    Most construction jobs are NOT skilled trades. SOME electricians,plumbers, masons are needed but mostly in supervisory role. I bet most workers are trained on the job. Why do you think it is so easy to hire undocumented workers for these positions?

  5. Its been a go-go-go economy most of my adult life. A slower economy may not be all bad. It could solve the illegal immigration problem (since there will no longer be a reason to come here). Fewer employed people means less traffic. Less traffic means less pollution. Let's just relax for a few years.

  6. TomKat

    Speaking as one who has run a house building firm in the U.K. your “Most construction jobs are NOT skilled trades” mantra is unquestionably true in the U.S.A.. But not in Britain. Nor throughout Europe. Over here you either know your trade, from full Apprenticeship right up to Journeyman or you are off the site faster than you can say “Jack Robinson” together with the firm imprint of a size 11 boot print on your backside. And that holds true for the lot: carpenters, plumbers, electricians, bricklayers (what Americans mistakenly call “masons”—masons carve stone they don’t lay bricks) right down to trenchers and labourers.

    “I bet most workers are trained on the job.” I bet they damn well are in the States where the quality of work is abysmal. I know because I’ve been there, done that too. But, you are not entirely to be blamed for this “bet”. American construction workmanship has declined dramatically over the past fifty years owing both to lower skills levels (Union busting) and the general de-skilling brought about by construction methods that favour “fixers” as opposed to craftsmen. Or what we call “tradesmen” in Britain. As an example: hanging a door by the traditional methods vs. door sets which any idiot can do.

    But, it may be six one, half dozen of the next when the modular is production and not quality. One of the most amusing sights I witnessed on a building site in New Jersey was of young men (boys actually) kitted out in work suits with no other tools than a hammer, an enormous steel tape measure together with a cordless circular saw calling themselves: carpenters helpers. Wot carpenters? God help us!

  7. What is a good short in commercial RE ?

  8. Anon, "Fewer employed people" might indeed be a good thing for the reasons you state. Unless of course, you're one of them.

  9. I live in Madison ,Wisc. a city whose main employers are the state gov, and the university. The economy is very stable. A good friend of min has a drywall business, He has cut back from 40 to 5 dry wallers. All are Hispanic with documentation, but all probably forged documentation. These workers never appeared in the employment rate and will probably never appear in the unemployment rate. If that rate of decrease took place in an area with no downturn I can't imagine what the true statistic is in the sunshine states.

  10. anon @ 9:07 PM,

    I've no idea of your age but 'a go go go economy' is correct. What must be understood, though, is that all this 'go go go' has never succeeded in reestablishing growth rates, productivity, rate of profit, etc, comparable to the 1950-1970 period, and that's been the case not only for the U.S. but the world econ as a whole. A fairly good but slightly long overview was published in a 2003 edition of the London Review of Books:

    Robert Brenner (director of the Center for Social Theory and Comparative History at UCLA) on the crisis in the US economy.


    Saddly, you are very correct about the deterioration in quality of construction. More, qualitative deterioration has increasingly become the norm in many other sectors.


    If I've not thanked you in the past, let me do so now and express appreciation for your ability to distill without overly reducing. Quite a talent.

    Do you know whether Shiller or ? might have data on CRE square footage added during the bubble?

  11. Not the subject...but i have a question regardning new jumbo limits.

    They are currently $417,000 across the board in CA i think...the "stimulus package" calls for increase of 125% of HUD determined median price, for instance in many areas of CA such as Sacramento, median price has fallen so much that 125% of it would be LESS than current $417,000...can someone confirm this?

    Thank You