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It isn't quite that simple. Real estate is one of the most widely-available assets that can be as levered as it is allowed in so many nations. This leads to pe

It isn't quite that simple. Real estate is one of the most widely-available assets that can be as levered as it is allowed in so many nations. This leads to perverse incentives. A property owner with a paid-up property can lever up, kick out tenants, post an out-sized rental rate, and use the credit to cover costs and missing income until a new tenant willing to pay the rental rate steps forward. Usually they step forward with the simple progression of time and inflation catching up to the new rental rate, or it's a business more heavily capitalized and banking on serving much more flush clientele (interesting discussions around the bifurcation of the economy and just how many businesses can thrive crowding into that wealthier end). This puts lots of incentive to keep inflating real estate valuations until the credit spigot is turned off. Meanwhile, the hands on the credit spigot gets paid by the velocity of credit granted, so they get lots of incentive to keep granting credit on inflated valuations. This circle turns until it doesn't, usually with some form of falling demand exposing who wasn't wearing swimsuits as the tide goes out. Contrast this with the asymmetric credit access available to most small businesses. They could have a longer tenure and track record than the present owners of the real estate, but still be considered a great risk because (rightfully) the credit granter will assess growth prospects to practically nil. So faced with a 200+ year old business that can definitely pay back $100K in five years, or a new property owner of the underlying real estate that might, maybe, possibly pay back $2M in 10 years if the right valuations can be signed off, which deal looks better come bonus time? This isn't a nefarious plot or the yield of some evil; it is simple human nature played out on the canvas of time and incentive structures. There are some interesting issues to ponder here with how agency, compensation and influence are structured in the valuations process, and how that ties in with the overall cycle. As well as many other factors that don't show up on an initial cursory take of the industry. But suffice to say...it isn't quite that simple. As for what can one individual do about it, that's a fascinating and long discussion in itself.

sokoloff 12y ago
I think your comment is very good and agree with virtually everything you say. That said, I think the difference in access to credit is driven in large part by the collateralization and very little to do with the growth prospects (IMO). The real estate loan is collateralized by a building and land which can be foreclosed upon in the case of default, dramatically lowering the worst-case outcome for the lender. That land and building might not be worth the face value on the loan (especially if there was a bubble pop type of event), but it's going to be worth something, probably something north of 60% of the loan's face value, which was probably capped at 75% of the apparent market value of the property for a commercial cash-out loan. In the case of a small business, especially an opex-heavy, capex-light business like a restaurant, what's the lender going to get in bankruptcy? The rights to the name of a recently failed restaurant and the picked-over remains of whatever equipment wasn't stolen or fire-sold during the last day of operation? The lender's downside asymptotically approaches 100% of the loan's face value. If my downside as a lender is 40% in one case and secured by a hard asset and 100% in another case secured by nothing, it's no surprise that people are lined up to make the first loan relative to the second. (There's also a strong, secondary market for performing and non-performing mortgage loans that has a far weaker parallel in the small business lending arena, but that secondary market's existence is largely a consequence of the collateralization. Yes, it also suffers from or contributes to the velocity point you make.)

sokoloff 12y ago

I think your comment is very good and agree with virtually everything you say. That said, I think the difference in access to credit is driven in large part by the collateralization and very little to do with the growth prospects (IMO). The real estate loan is collateralized by a building and land which can be foreclosed upon in the case of default, dramatically lowering the worst-case outcome for the lender. That land and building might not be worth the face value on the loan (especially if there was a bubble pop type of event), but it's going to be worth something, probably something north of 60% of the loan's face value, which was probably capped at 75% of the apparent market value of the property for a commercial cash-out loan. In the case of a small business, especially an opex-heavy, capex-light business like a restaurant, what's the lender going to get in bankruptcy? The rights to the name of a recently failed restaurant and the picked-over remains of whatever equipment wasn't stolen or fire-sold during the last day of operation? The lender's downside asymptotically approaches 100% of the loan's face value. If my downside as a lender is 40% in one case and secured by a hard asset and 100% in another case secured by nothing, it's no surprise that people are lined up to make the first loan relative to the second. (There's also a strong, secondary market for performing and non-performing mortgage loans that has a far weaker parallel in the small business lending arena, but that secondary market's existence is largely a consequence of the collateralization. Yes, it also suffers from or contributes to the velocity point you make.)