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Since the fourth quarter of 2007 when the commercial mortgage-backed securities (CMBS) market effectively seized up, there has been concern that lax underwriting in residential lending would bleed over into commercial real estate loans. Furthermore, if the latter underwriting was indeed less than stellar, how much exposure would U.S. banks and brokers face from commercial real estate loans?

According to a recent report by New York City-based Fitch Ratings, “Commercial real estate and CMBS exposures will likely exacerbate credit problems at U.S. banks, many of whom are already facing significant risk from troubled residential real estate exposures.”

As of the fourth quarter of 2007, losses on large bank commercial real estate loans had expanded to 48 basis points, up from 7 basis points in the previous eight quarters — largely attributable to the risky construction sector. Fitch expects losses for all commercial real estate loans to increase by 75 basis points beyond fourth-quarter levels. In context, construction loan delinquency rates typically average about 60 basis points, but were up to 3 percent in the fourth quarter of last year. Of the five major sectors, office makes up 31 percent of CMBS collateral followed by retail (30 percent), multifamily (17 percent), hotel (9 percent) and industrial (5 percent).

The outlook for the retail sector is weak, according to Fitch. “New space is being completed at a much faster rate than can be absorbed,” reports Fitch. The trend has resulted in vacancy rates of up to 11.4 percent in Memphis and 10.8 percent in both New Orleans and Jacksonville, Fla. The most overbuilt residential markets, including Florida, the Inland Empire and Sacramento, Calif., may also experience weakness in retail.

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