The new world crisis has begun and it is in the commercial real estate sector

By | May 9, 2023

Executives and investors worry about the impact of rising interest rates and empty buildings in a $5.6 trillion market

For a new crisis, this time in the US commercial real estate market, which amounts to 5.6 trillion dollars, but also worldwide, they warn fund managers…
More specifically, fund managers are warning of growing problems in the US commercial real estate industry, which could prove particularly painful for banks already hit hard by the recent banking turmoil.
Rising interest rates, falling property prices, and falling demand for office space after the pandemic are putting pressure on the commercial real estate market.
But these problems intensified after their bankruptcies Silicon Valley Bank, Signature Bank and First Republic; which caused great concern for the health of other regional banks, which account for the bulk of commercial real estate lending.
“The private market has not started to reduce its real estate holdings,” its co-chairman told the Financial Times. apollo Global Management, Scott Kleinman.
“Private capital will be hit first.
This is the “next shoe” to drop in the US.
Like everything else, it’s priced right and there hasn’t been a commercial real estate crisis in the US since the 1990s.”
Your investment manager Guggenheim Associates, Anne Walsh, He said some areas of the US would be hit the hardest, including major urban centers like San Francisco and New York, as well as second-tier office buildings in need of repair.
“We’re probably going to go into a recession in the housing sector, but not in the entire housing market,” Walsh said.
“Banks will have to become very selective about the loans they are willing to make.”
He noted that some banks have required personal guarantees from homeowners, in which borrowers pledge their own assets to secure a mortgage, a sign of tougher credit standards and that banks are in trouble.
in his research Federal Reserve published Monday, May 8, most US banks said they tightened credit standards for loans collateralized by nonresidential real estate in the first quarter, while none eased them.
At the same time, a wall of debt is coming down that must be repaid in the coming years.
“There is a maturity cliff for many of these properties, a significant part of which is financed by regional banks,” said the chief executive of a major US bank.
“Commercial real estate is leverage, leverage, leverage”…
If people are forced to quickly get rid of that leverage, it can show up elsewhere.”
For many years, developers relied on cheap loans and invested money in a market of rising asset prices.
Now, as Mathieu Chabran, its co-founder, said Tikehau Capital which manages $43 billion in assets, “we are seeing a perfect storm of rising interest rates, which… are forcing asset revaluations, combined with a structural decline in employment rates and asset maturities” .

What Charlie Munger and Warren Buffett say

Last month, Berkshire Hathaway vice president Charlie Munger warned of a storm in the US commercial real estate market, saying banks were “full” of “bad loans.”
“A lot of properties aren’t that great anymore,” Munger said.
“We have a lot of troubled office buildings, a lot of troubled shopping malls, a lot of other troubled properties.
There’s a lot of anxiety out there.”
Munger, of course, added that the problems are not on the scale of the 2008 financial crisis.
At Berkshire’s annual general meeting in Omaha on Saturday, Munger partner Warren Buffett pointed out that it’s the banks that often end up with unwanted property.
“Banks tend to stretch and fake it,” he said.
“Many types of activity arise from commercial real estate development, but they all have consequences, and we’re starting to see them in citizens who were able to borrow at 2.5% and find it’s no longer feasible at current rates.”

CRE… and the risk v. Howard

“While I do not foresee widespread contagion, either psychological or financial, from the SVB bankruptcy, I cannot end a note on US banks without mentioning one of the biggest concerns they face today: the possibility of problems arising loan-to-value ratio of commercial banks”. real estate (CRE), particularly for office buildings,” reports the legendary Mark Howard, adding:
“The following factors are impacting the CRE sector today:
Interest rates have increased significantly. While some borrowers do benefit from fixed rates, about 40% of all CRE mortgages will need to be refinanced by the end of 2025 and, in the case of fixed rate loans, possibly at higher rates.

1. The higher interest rates require higher required capitalization rates (the ratio of a property’s net operating income to its price), which will drive property prices down.
2 pm possibility of recession it portends negative things for rental rates and occupancy, and therefore for the income of the owners.
3 hrs credit it is likely to be limited next year.
4. The people occupying office buildings five days a week is in doubt due to the remote work model, which threatens the underlying business model of the owners.
5. The total assets of US banks exceed $23 trillion.
Banks collectively are the largest real estate lenders, and while we only have rough ranges for the data, they are estimated to hold about 40% of the $4.5 trillion in outstanding CRE mortgages, or about $1.8 trillion in face value. .
Based on these estimates, CRE loans represent around 8-9% of average bank assets, which is significant.
(Total CRE exposure may be higher.)
However, CRE loans are not spread evenly across banks: some banks are concentrated in parts of the country where real estate markets have been “hottest” and therefore could experience larger percentage declines.
Some borrowed against lesser quality properties…
Some originated mortgages with a higher loan-to-value ratio • and some have a higher percentage of their assets in CRE loans.
recent report of Bank of America shows that the average exposure to CRE loans is only 4.5% of total assets in banks with more than $250 billion in assets, while it is 11.4% in banks with less than $250 billion in assets.
Since the banks are so highly leveraged, with only $2.2 trillion in capital (about 9% of total assets), the estimated amount the average bank has in CRE loans is equal to about 100% of its capital.
Therefore, CRE mortgage losses on the average loan book could wipe out an equivalent percentage of the average bank’s capital, leaving the bank with negative equity.
As the BofA report notes, the average large bank has 50% of its risk-based capital in CRE loans, compared to 167% for smaller banks.
In this context, significant defaults on office building mortgages and other CRE loans are highly likely.
But this does not necessarily mean that the banks involved suffer losses.
If the loans were made at a reasonable LTV ratio, there would be enough principal under each mortgage to absorb the losses before the banks’ loans were compromised.
Also, mortgage defaults usually don’t mark the end of the story, but rather the beginning of negotiations between lenders and homeowners.
In many cases, the result is likely to be an extension of the loan on restructured terms.
No one knows if banks will take losses on their commercial real estate loans, or how much.
But it is very likely that we will see defaults, and this could scare banks, sabotage financing and refinancing processes and contribute to a greater sense of risk, Oaktree Capital concludes.

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