By Bernard Winograd

As the U.S. housing market continues to weaken, predictions that a similar fate awaits commercial real estate are growing more frequent and increasingly bold. While such forecasts are understandable in the face of what could be the worst housing market downturn since the Great Depression, the surprisingly widespread confusion regarding the differences between residential and commercial real estate has exacerbated the problems that U.S. REITs face today, threatening to further constrain commercial real estate's access to capital.

To be sure, residential and commercial real estate share more in common than the words "real estate." Both markets comprise a significant share of the investable universe. In terms of value, the roughly $20 trillion U.S. residential market is approximately 45 percent larger than the U.S. stock market and dwarfs the $6 trillion investable universe of commercial property.

Likewise, both residential and commercial real estate are capital-intensive and, therefore, typically rely heavily on long-term financing, such as mortgages, secured by the underlying property. Both residential and commercial property have provided a decent hedge against inflation and relatively low return volatility, compared with publicly traded stocks and bonds. However, the similarities largely end there.

Much of the confusion today, of course, can be traced to the ongoing troubles in the residential mortgage market, especially at the subprime end of the credit spectrum. As the media has correctly reported, the residential market is going through a painful correction due to a combination of factors, most notably an excessive supply of new homes and condos, overly aggressive lending practices and shoddy "underwriting" predicated on continued home price appreciation and abnormally low interest rates. Eager, perhaps, to avoid missing another such obvious impending disaster, many observers in and out of the media already have concluded that commercial real estate will follow a similar path.

This conclusion is, at best, unfortunate because it ignores important differences between the two markets that should be readily apparent to anyone who looks beyond superficial similarities. Most importantly, commercial properties, unlike most residences, are purely investment assets. They are bought, sold and managed by sophisticated investors, and they are underwritten on the basis of the income-producing potential of the asset, not the credit-worthiness of the borrower, as in the residential market.

The increasingly negative view toward commercial property has had relatively little impact so far on private capital market sources. For the most part, private equity and debt remain available for a broad range of commercial investment opportunities. But it has seriously undermined demand for U.S. REITs and commercial mortgage-backed securities (CMBS). This poses a growing threat to commercial property values.

Fortunately, new supply of commercial space has remained relatively modest in recent years, unlike in the residential market. Additionally, supply and demand are generally well balanced in most markets. Hence, while healthy space market fundamentals may do little to alleviate the pressures for highly leveraged borrowers who need to refinance in the short-term, the commercial market should not experience anywhere near the deterioration in mortgage portfolios that we've seen in the residential market, unless demand contracts sharply.