The Dynamic Relationship between Delinquency Rates, Funding and Market Liquidity and Asset Prices in Private Commercial Real Estate Markets

We employ a panel vector auto-regressive model to analyze the dynamic interactions between delinquency rates on bank loans, funding and market liquidity, and asset price movements in regional U.S. commercial real estate (CRE) markets. Our findings indicate that rising delinquency rates lead to tighter funding liquidity, which in turn negatively impacts asset prices and market liquidity. Importantly, funding liquidity and market liquidity reinforce one another, demonstrating that “liquidity spirals” are also relevant in CRE markets. Additionally, there is a negative feedback loop between market liquidity and default rates: good market liquidity allows borrowers with financially distressed loans to sell properties before becoming delinquent. This highlights the crucial role of market liquidity in CRE markets. Based on these insights, we recommend counter-cyclical loan policy standards. In hot markets, tighter funding liquidity may reduce future delinquency rates, while in cold markets, more relaxed lending standards could enhance market liquidity. This may facilitate restructuring and refinancing of distressed loans, helping to mitigate liquidity spirals.

Keywords: Funding liquidity; Market Liquidity; Commercial Real Estate; Delinquency Rates;
JEL codes R3; G21; G12;

Working paper no. 835