ALL BUSINESS: a Tale of Two Real Estates

The alarming rate that subprime borrowers have defaulted on their mortgages over the last year has caused a widespread tightening of credit, with lenders everywhere raising their borrowing standards and investors shying away from anything they perceive to be risky.

Those seeking commercial loans are seeing that first hand. The Federal Reserve's latest survey of senior loan officers showed 80 percent of domestic banks tightened their lending on commercial loans from October through January, the highest level since that question was first asked in 1990. That means borrowers are having a tough time refinancing loans.

Beyond that, Goldman Sachs estimates commercial real estate prices could drop 21 to 26 percent from current levels. The American Institute of Architects' Architecture Billings Index fell in January for the first time in three months, a leading indicator for weak construction growth in the months ahead. The International Council of Shopping Centers projects 5,770 stores could be closed this year, the largest number in four years.

All that negative data still doesn't support the distress signal being sent by the CMBX index, however. It's flashing doom, but there are good reasons to think the situation is not that dire.

To start, actual delinquencies on commercial mortgage bonds were at a tiny 0.28 percent at the end of 2007, according to Fitch Ratings' Commercial Mortgage-Backed Securities Index covering 48,000 loans. Even if that rate goes up as it is expected to do it still isn't anywhere near the double-digit default rates now being seen on subprime loans.

Also, the loans backing commercial properties are considered to be less risky than subprime mortgages, which often didn't require borrowers to show documentation of income or were given to individuals with low credit scores.

Derrick Wulf, a portfolio manager at Dwight Asset Management in Burlington, Vt., notes that commercial loans are underwritten based on financial statements, rent rolls and site visits, and there is a lot more "due diligence done on a $100 million office building than a $150,000 subprime loan."

"Commercial properties are income producing assets, often with long term in-place revenues and a diversified corporate base," Wulf said. "They can continue to produce positive net incomes even when their prices decline."

Lastly, only 28 percent of commercial mortgages since 1995 versus 80 percent of subprime loans are securitized, meaning they are sliced up and sold to investors as securities. That means the losses on those loans can be recognized more slowly by banks and other financial institutions, and they won't create the same capital pressure as subprime losses have. Instead, they will create an "earnings drag," Goldman Sachs said.

The outlook for commercial real estate isn't pretty, but it also may not be as ugly as some expect it to be.