Does CRE Pose a Risk to the Financial System?

Executive Summary

There appears to be an incredible amount of commercial construction taking place in many American cities today. With memories of the housing market implosion of the last decade still fresh in many minds, it is natural to wonder if a bubble is developing in the commercial property market. If so, could the financial system be brought to its knees as it nearly was a decade ago? We are not overly concerned about commercial real estate (CRE) at this time. For starters, fundamentals in the CRE market appear to be fairly solid at present. Moreover, the nation’s banking system does not appear to be overly exposed to commercial mortgages. There are a number of factors that could trigger the next U.S. recession, but we do not believe that a sharp downturn in the nation’s CRE market will be the catalyst.

Is Commercial Real Estate Overbuilt?

Anyone who has spent time recently in America’s cities, even smaller ones, will note the incredible amount of construction activity that appears to be underway. Construction cranes seem to permeate the skyline. And this anecdotal evidence of strong activity in CRE is generally supported by hard data. Private nonresidential construction spending has grown at a solid rate through much of this expansion (Figure 1). There are currently about 300,000 open jobs—a record number—in the construction industry, which has led to a 3% rise in construction wages over the past year. This acceleration in wages in conjunction with rising costs of materials have put upward pressure on the overall cost of construction.

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