Commercial Real Estate Prices: What Inference to Draw?
My latest column for the Atlantic looks at the commercial real estate crash and comes to the conclusion that it effectively undermines the major narratives that many people have adopted to explain the residential bubble. Though the commercial real estate bubble was smaller in scope than the residential one, it was characterized by essentially the same pathologies: rising prices, stupid banks, and stupid borrowers.
Paul Krugman contributes a graph showing that commercial real estate prices followed a similar arc to residential real estate prices in the past decade.
I would not make such a big deal of this. First of all, land is land. It is not surprising that residential and commercial prices move similarly. It would be more puzzling if they diverged.
Having said that, my guess is that in most periods you would see somewhat less volatility in residential real estate prices than in commercial real estate prices. I would think that commercial real estate would tend to be somewhat more sensitive to interest rates and to economic conditions than residential real estate, where prices are probably stickier.
My guess is that the cycle in commercial real estate prices can be explained pretty well by (a) the normal response of that market to interest rates and economic conditions and (b) the sharp movements in land prices due to the housing bubble/bust. My guess is that only a relatively small component of the swing requires a story of irrational investor expectations. (Of course, if you think that commercial real estate investors should have been able to read the housing bubble, then you can argue that a much bigger component of the commercial bubble reflected irrational expectations.)
McArdle and Krugman want to say, “Gotcha! All of your theories of the bubble that are specific to housing and mortgages need to be tossed out. Instead, you need a theory that can simultaneously explain a commercial real estate bubble and a housing bubble.”
Sorry, I don’t accept the “gotcha.” The housing-specific component of the bubble was really, really important, and the component specific to commercial real estate much less so.
[UPDATE: Scott Sumner is with me on this one.]