Foong on Finance: Real Estate Bubbles

By Keat Foong, Executive Editor

When reporting on multifamily finance in the 2000s, I came across a common refrain from desperate mortgage bankers again and again: “There is a surplus of money chasing a limited amount of product.” This intensely competitive environment—for lenders, that is—went on for years, seemingly never ending. But the capital “surplus” environment did come to an end.

What Sam Chandan, chief economist of Reis, said recently at the company’s third quarter briefing throws light on the situation. He cited an essay about banking crises. Such a crisis happened, famously, in Japan in the 1980s. The cycle begins thus: There is some sort of initial loosening of credit in the economy. The subsequent great abundance of credit brings about a real estate bubble. Eventually, that bubble bursts and asset prices deflate. The banks' asset values also fall, they cannot lend as much, and a recession occurs.

Indeed, there was much abundance of capital in the multifamily sector during that period, and it was driven in large part by CMBS financing. The point is that multifamily asset values may also have been pushed up by the great availability of credit. There was much talk then of cap rates being squeezed down to ridiculous levels by highly leveraged buyers. The question is, was there also a bubble in multifamily asset prices, and if so, what was the magnitude?

This issue’s report “Apartment Property Prices Have Fallen by 17% Since Last Year” suggests that the numbers at least do not show severe distress yet. Prices per unit/square foot for apartments in the third quarter of 2008 was 17 percent below its peak in the third quarter of 2007, according to Reis. Chandan says that transaction cap rates for apartments in the third quarter have increased by just under 40 basis points, to 5.7 percent. Apartment cap rates had hit a low of 5.4 percent, in the third quarter of 2007. That is the latest report.