A major reason why lenders periodically experience significant credit problems on commercial real estate loans is the property cycle, which is closely related to developers’ misforecasts. For example, the Asian recession started the same way as it did in the United States and Europe, beginning with extensive lending and the resulting overbuilding of commercial space.

A unique characteristic of real estate property is its longevity, and a feature of property development is a long delay between orders and completions. There also exist lags created by the need to acquire and development sites, area planning and land use changes, evaluate the load/bearing and other capacities of the site, obtain access to financing, draw up plans, and obtain building permissions. A typical project might take two to three years from the beginning to end.

The combination of a long time lag from initiation of a development project to completion, optimistic expectations about future demand for space, the macroeconomic situation, and a short-run supply which is irreversible and specific to both location and use, creates the conditions for a classic “hog-cycle” whereby the market alternates between bust and boom.

There is a long delay before increased user-demands for commercial property can be translated into additional property stock sustains space shortage. This can lead to rising rental or real estate values. Therefore, rising prices induce developers to initiate new construction. But in the short run, the effect on demand and supply can be even perverse. Potential tenants may sign contracts and acquire properties ahead of time in anticipation of rising rents, while the increase in real estate prices enables property trades to increase their borrowings and purchase more real estate.

Eventually, the supply of new space adjusts to changing user and investment demands, but under perhaps very different economic conditions, producing an excess supply of space and decreasing rents and real estate prices. Most of the adjustments in commercial real estate markets depend upon developers (suppliers). As the market alternates between a phase of over- and under supply to cyclical fluctuations in development activity is thus generated.

Putting these elements together, we might draw the profile of a typical property cycle:

1. Rents begin to rise and real estate values increase

2. It pays to renovate buildings and the volume of new construction expands

3. Increased lending and new sources of equity investment

4. Development lots and vacant land are absorbed

5. Optimistic forecasts of market growth and trends and “the boom that will never end” thinking sets in

6. Available supply begins to come to the market

7. At the peak of cycle all real estate factors now at full stretch, there is an equilibrium between supply and demand

8. Reduced take up and unstoppable supply of space

9. Rent decreases and falling property values

10. Tightened lending and foreclosures

11. Depressed property values and minimal construction activities

12. Banks reverse their boom policies and start to withdraw loans

13. The “wreckage” is cleared away and the real estate market stagnates

14. Increased absorption and stabilizing rents and values

15. Recovery and the readiness for another take up

Vincent Hanna works as a financial planner and offers debt consolidation advice and guidance in his blog http://www.caaza.net/. Do not wait for things to get worse and for your credit report to become irreparable, find out what to look for in a debt service today to help you improve your financial situation and the quality of your life.