Commercial real estate lending by banks trended higher once again in the second quarter of 2014, reflecting growth in the pool of well-qualified borrowers as well as lenders' increased tolerance for risk-taking. Rather than the bifurcation of capital flows observed early in the real estate recovery, lending has become increasingly balanced in terms of its geographic and property type dispersion. Alongside the conduit and other balance sheet lenders, the tally of banks actively engaging the market has increased steadily.

According to Chandan Economics' independent analysis of bank call reports, net multifamily lending by banks increased $9.5 billion from the first to the second quarters; commercial real estate including owner-occupied properties but exclusive of multifamily, by $8.1 billion; and, construction loans, by $8.6 billion. As compared to a year earlier, net lending across these categories increased by more than $100 billion. That is a national aggregate that encompasses all property types, but it nonetheless reflects broad increases in activity.

While news of strengthening capital flows is generally well-received by the industry, it demands evaluation in context. Commercial real estate lending is highly pro cyclical, rising alongside property sales and prices while underwriting standards move in the opposite direction. On this last point, the inverse relationship between competitive lending and the long-term performance of contemporaneous loan vintages is fairly consistent across previous real estate cycles. Not all are bad, but bad loans get made in good times.

Anticipating future delinquencies and defaults is a forecasting exercise, allowing for debate over the quality of today's loans. Absent perfect foresight and an unambiguous measure of quality, evidence of credit migration can nonetheless inform our sense of the market's direction. Among the metrics that have shown some utility in this regard, the growing share of mortgages with interest-only components and the share of loans underwritten to marginally higher-than-observed net operating income should not be dismissed.

Instant Insights /

As Lending Rises, Procyclical Features Reemerge

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