Given the size of the industry (compared to, say, residential housing), under most circumstances it cannot; we know from the S&L crisis, however, that problems in our sector can be enough to cause a recession. The 1990s bust was all about newly built buildings that weren't needed when they arrived; this time around, overbuilding was not the problem, overvaluations were. So where does that leave us?

First, some perspective on the size of the market. Under most conditions, commercial real estate is more the tail, while the economy is the dog. Even during the 1990s downturn, the GDP decline was more a function of decreased residential investment than of investment related to nonresidential structures. The graph below plots out residential and structures investment related to GDP. One can see why the decline in housing construction has been such a drag on U.S. output in recent years. One can also conclude that decreased non-residential construction will be a drag on U.S. output in the coming year, likely creating a 1% decline in headline output. In short, commercial real estate will be a problem for the economy but would not be an insurmountable one, were economic health about output alone.
 
The contribution of commercial real estate does not end with its construction output. Contrasting with dollar measures of output, construction employment numbers for real estate's two segments run relatively close to one another. For example, at the end of 2005, 3.4 million workers were devoted to residential construction and contracting while 3.2 million workers were devoted to nonresidential construction and contracting. As of our last reading in August, 2.3 million workers remained in residential, and 2.9 million in nonresidential. In the case of both output and workers, the longer time frame of nonresidential building and the fact that these measurements are recorded when the projects are finished are contributing to the increase in nonresidential's percentage in the last two years. As we know that many fewer projects are planned and underway than before, nonresidential workers and output should both be expected to drop sharply in 2010.

But both numbers are measures of the contribution of commercial real estate through construction. Perhaps more important—and why commercial real estate tends to get the blame for the S&L crisis—is the contribution to values in the financial markets. That is, in addition to construction, the ownership of commercial real estate is an important contribution to the store of value on many balance sheets. In our most recent update last year, we estimated the value wrapped up in the commercial real estate mortgage market to be $3.4 trillion, with an additional $1.6 trillion in equity. As with the value of existing houses, the implications for declines in these values can reverberate through the economy.

In particular, many government entities have a stake in commercial real estate values, as pension funds hold a much higher proportion of their assets in commercial real estate than does the general public. With many states and municipalities placing a higher tax rate on commercial assets than on residential, a change in commercial values can have a disproportionate effect on government coffers as well. The other large stakeholders in commercial real estate values include the banks and insurance companies; returns over extended time frames on commercial real estate assets are usually a good match for their liabilities. Holders of CMBS and REITs—the public instruments for commercial real estate—have played an increasing role over the past two decades.

Even if the size of the decline absorbed by the market were to approach $2 trillion in write-downs over time with much of the adjustment having already occurred, we would still not be up to the estimated $6 trillion lost in housing wealth or $7 trillion lost in the U.S. stock market downturn. This would be comforting were it not for the lessons learned from the run-up to the downturn of 2007. A more appropriate point of comparison for the overall economy—and admittedly, a comparison that we made at the time—is that the subprime mortgages only totaled about $1.3 trillion in value at the time. If we underestimated this sector's influence on the economy in early 2007, what we have learned about interdependency and complexity in the financial system should surely give us pause today if we are tempted to ignore the impacts that the commercial real estate value declines will have despite their relative size.

The balance that needs to be struck is, on the one hand, not to minimize the severity of the problem and its potential to do harm, and, on the other, not to think that the inevitability of more problem commercial real estate loans and further declines in values should automatically portend a recession. In fact, our base-case economic forecast is for improvement in output and employment, even as the commercial real estate sector lags in its turnaround. This forecast depends, however, on banks, owners, and government being attentive to the problem at hand and replacing some of the liquidity lost in the downturn and credit crunch of the past two years.