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Why the commercial real estate crash never came – The Term Sheet

September 24, 2013

FORTUNE — Hilton Worldwide recently announced plans to return to the public market, after The Blackstone Group (BX) took the hotel giant private in 2007.

The private equity firm is eager to recoup some of the $26 billion it paid for the chain just before the credit crunch. Whether Blackstone will be successful remains to be seen, but the initial public offering comes as the hotel industry, and more broadly, the commercial real estate market, turns around.

Less than four years ago, lawmakers and executives warned that the market for hotels, malls, apartments and office buildings would be the next to collapse, after countless homeowners lost their homes to foreclosures. While prices across the commercial real estate declined almost 40%, it never quite crashed like the housing market. Yes there were foreclosures and defaults, but not to the scale of housing.

There are a few reasons why the crash never came, which also help explain how commercial real estate has recovered much faster than the market for homes. Unlike residential, the commercial market didn’t bubble up nearly as much as housing; it was not nearly as overbuilt, either.

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This had a lot to do with timing, says Casey Mulligan, economics professor at the University of Chicago. The boom in home construction took workers, materials and land away from the commercial sector. It was only after 2005, when the housing market bubble burst, that more of these resources freed up and construction projects started picking up — but that was short-lived since the financial crisis shortly followed.

While there were defaults, the commercial market didn’t see nearly as many foreclosures as the housing market. Joblessness and plummeting home prices led many to miss mortgage payments, which led to the wave of defaults. Commercial properties saw similar price declines, but unlike residential properties, owners enjoyed continuous flow of income by way of rents from tenants. This gave owners struggling with the credit crunch considerable relief.

“There were defaults in the commercial space, but it didn’t hit the heights seen in the single-family market,” says Susan Wachter, real estate and finance professor at the University of Pennsylvania’s Wharton School of Business. Rather than a wave of defaults, the real estate crash triggered a wave of workouts whereby banks renegotiated the terms of loans, sold to new owners or took the properties over. Private equity firms also swooped in and bought up distressed properties.

“Any solution did not trigger excess supply in the market,” Wachter adds. “It was almost a nonevent in the commercial space.”

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On average, prices regained all the ground that was lost during the downturn, according to the monthly index by Green Street Advisors that tracks commercial real estate prices. While office industrial buildings have a ways to go, prices for apartments, high-end malls and strip centers are well above their prior peak.

Hotels, in particular, have recovered in big ways as stocks soar and the economy improves. And Hilton’s move to go public is the latest example. With hotel stocks close to a five-year high and revenue and profits growing industry-wide, investors are taking advantage of the stock rally to sell assets.

Hyatt Hotels (H), the chain controlled by Chicago’s Pritzker family, raised $1.09 billion in an IPO in 2009; it rose 12% on its first day of trading. Since the IPO, shares have gained 77%.

Caesars Entertainment (CZR), the casino chain that also operates hotels, sold shares to the public last year, after private-equity owners Apollo Global Management LLC and TPG Capital took the company private about four years ago. Since the IPO, shares have risen 81%.

The crash in commercial real estate may or may not have happened, but if it did, it probably wasn’t as bad as many thought.

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