A Decade of Defaults

Markets tend to myopia in times of extreme optimism. Rising prices fuel a brighter outlook, drawing additional capital and more favorable credit terms. For a moment, a market’s momentum can overwhelm the inertia of rational behavior. Prices decouple from fundamentals. This pattern might describe any sector. In specifically describing the last decade’s upswing and downturn in commercial real estate, property markets have earned their peerage with other mainstream asset classes over the last decade.

Leading up to the peak of capital inflows to the sector, the assessment of risks associated with lending against commercial property adjusted in favor of current metrics and away from long-term cyclical measures. Some lenders offered credible arguments that structural changes in the industry meant that more recent data was more relevant. For other lenders, the bias in default and loss expectations did not reflect a greater tolerance for risk; in many cases, it simply reflected a basic mismeasurement of those risks in a worldview where defaults and losses could be obviated by the resilience of a positive and uninterrupted pricing trajectory.