WASHINGTON, DC-The city and surrounding area may be a top investment destination but that didn’t stop Sam Chandan, president and chief economist of Chandan Economics, from downgrading its forecast for the performance of newly-originated core multifamily and commercial real estate loans in its December credit risk report.  Why? For starters, “because 3Q and 4Q originations have limited cushion against downside risks to space demand that might follow from government cuts,” he tells GlobeSt.com.

In fact, there are several factors behind the slight drop in the credit outlook, none of which alone seem to be that significant—but taken as a whole spell a rocky period ahead for the District.
 
Says Chandan: “There is a wide range in the quality of recent loans. Nonetheless, the potentially pro-cyclical lending trend and its impact on pricing warrant a greater degree of scrutiny by lenders and investors in the DC area.”

There is a higher probability of default and loss severity projections for newly originated multifamily and commercial real estate loans backed by core DC properties, the credit report finds. 

In addition, as prices for DC's core office and apartment properties have risen, competition amongst lenders to finance sales and refinance maturing debt has forced an easing of lending standards. “Apart from narrower lending spreads over risk-free rates, terms on core property loans have shown a reduced sensitivity to leverage and other risk drivers in the third and fourth quarters,” Chandan says.

Then, interest rate risks are magnified by the potential for medium-term structural shocks to DC"s labor market. “Stress tests of multifamily and office fundamentals performance show an increase in default and loss rates as a result of these downside risks.”

While the current budget debate may fail to bear fruit, he continues, the purpose of the stress tests is to assess property and loan performance across a range of credible scenarios. “Scenarios involving drops offs in the metro area's employment drivers and the sensitivity of refinancing to higher inflation or maturity borrowing costs are important offsets to the general enthusiasm for DC assets,” he says. “A reflection of that enthusiasm, the data show that recently originated loans have limited cushions to absorb sustained stresses.”