The drumbeat for reform in the residential mortgage market due to lax underwriting standards has been growing in recent months, but there has been virtually no push for regulation of commercial mortgage lenders. Why?
Industry experts say that the size and complexity of commercial real estaterequires a high degree of transparency that generally precludes the kind of abuses that have surfaced in the residential sector. Besides, experts add, regulations today won't do much to ease the current credit slowdown.
“We self-regulate, and the size of the loans makes it work because the stakes are clearly much higher than on the residential side,” says Kieran Quinn, chairman of Column Financial in Atlanta and chair of the Mortgage Bankers Association in Washington, D.C. “A lot of commercial mortgage banking firms have been around for 50 to 100 years,” he says, “and they've been successful over a long period of time because they take responsibility for the process.”
Though the U.S. government said in mid-March that it would pursue tighter regulation, it's unclear what form it will take or if it will affect commercial loans. There is a lot at stake. Domestic issuance of commercial mortgage-backed securities reached about $230 billion in 2007 and that doesn't count the billions of dollars of non-securitized loans.
Jim Spitzer, a partner at the law firm of Holland & Knight in New York, says increased regulation of commercial lending is unnecessary. “The lender may help facilitate getting bids,” says Spitzer, “but commercial investors are so sophisticated that the mortgage person doesn't affect the structure of the transaction in the way that residentialdo.”
But Anthony Downs, a senior fellow at the Brookings Institution in Washington, D.C., says self-regulation has been lax. “There was too much money trying to buy commercial real estate after the stock market crash of 2000, and lenders reduced their underwriting and simplified their terms, which made it easier for people to buy who shouldn't have bought,” he says.
That's led to a standoff, explains Downs. Easy lending drove commercial real estate prices higher. But sellers won't reduce their prices, buyers won't buy at current prices, and lenders need to charge more to cover their risk. Allowing the market to come to a standstill after the fact, he says, isn't an effective way to curb the initial problem of lenders failing to police themselves.
Quinn admits that self-regulation didn't work in the 1980s, when many savings and loan institutions went belly up after funding hoards of commercial projects that sat empty. But commercial lenders learned from the S&L crisis, Quinn believes, and the subprime mortgage crisis has forced residential and commercial lenders to re-examine their practices. “We're already looking at deals more critically,” he says.
Spitzer agrees. “I don't see a lot of overbuilding in the commercial marketplace now,” he says. “It's been much more disciplined, whether it's because of self regulation or the nature of the discipline that comes from the marketplace.”
But Downs says increased regulation might have prevented lenders from relaxing their underwriting standards in the first place. “Right now the solution to the credit crunch in commercial property can't be imposed by regulation. There has to be a change in the mindset.”
Even in hotter markets, Holland & Knight's Spitzer doesn't see the need. “I don't believe increased regulation will provide any greater protection than the free market already does.”