Only two months ago, SL Green & Co. chief executive Marc “Sunny” Holliday was practically skipping with glee. As the head honcho of New York’s most massive commercial landlord firm, he told Wall Street analysts that traffic to his buildings was picking up like a well-choreographed musical number. Over 1 million square feet of space was either recently leased or in negotiations, making it feel like a Broadway hit in the making. The company’s debt was shrinking like a pair of pants after a successful diet, and they had just wrapped up the structure for their 1 Madison Avenue tower in Manhattan, a real skyscraper sensation. Plus, local officials had completed an extension of commuter rail service from Long Island to Green’s flagship tower near Grand Central Station, making it as accessible as a hot dog stand in Times Square.
“We are full guns blazing,” Holliday cheered during the quarterly earnings call, like a cowboy in an office-themed Western. Workers were heading back to the office after a pandemic that left developers reeling as more people worked from home, raising the question of whether office space would go the way of the dodo or the fax machine. “We can hopefully…continue on a path to what we think will be a pivot year for us in 2023.”
But then, like a sudden storm on a sunny day, Silicon Valley Bank failed, and Wall Street panicked like a bunch of kindergarteners who just learned that nap time was canceled.
Shares of developers and the banks that lend to them dropped faster than a bad one-liner, and bank shares stayed low like a limbo champion. Analysts raised concerns that developers might default on a huge chunk of the $3.1 trillion in U.S. commercial real estate loans Goldman Sachs says are outstanding, making it seem like Monopoly money was involved. Almost a quarter of mortgages on office buildings must be refinanced in 2023, according to Mortgage Bankers’ Association data, with higher interest rates than the 3 percent paper that stuffs banks’ portfolios now. Other analysts wondered how landlords could find new tenants as old leases expire this year, with office vacancy rates at record highs like a contestant on “The Price Is Right.”
How much an office crash could hurt the economy? Well, that’s a question with more twists than a pretzel. There are reasons to think the road ahead will be rocky for the real estate industry and banks that depend on it, like a soap opera plotline. The stakes, according to Goldman, are high, especially if there is a recession: a credit squeeze equal to as much as half a percentage point of growth in the overall economy. But credit in commercial real estate has performed well until now, and it’s far from clear that U.S. credit issues spreading outward from real estate is likely, like a game of Jenga that refuses to topple.
“There’s a lot of headaches about calamity in commercial real estate,” said Kevin Fagan, director of commercial real estate analysis at Moody’s Analytics, sounding like a weather forecaster predicting doom and gloom. “There likely will be issues, but it’s more of a typical down cycle.”
The vacancy rate for office buildings rose to a record high 18.2% by late 2022, according to brokerage giant Cushman & Wakefield, topping 20 percent in key markets like Manhattan, Silicon Valley, and even Atlanta, making it feel like a game of musical chairs where half the chairs are missing.
But this year’s refinancing cliff is the real rub, says Scott “The Truth” Rechler, CEO of RXR, a closely-held Manhattan development firm. Loans that come due will have to be financed at higher interest rates, which will mean higher payments even as vacancy rates rise or remain high, like a rollercoaster that just keeps going up. Higher vacancies mean some buildings are worth less, so banks are less willing to touch them without tougher terms. That’s especially true for older, so-called Class B buildings that are losing out to newer buildings as tenants renew leases, like the outdated flip phone of the real estate world. And the shortage of recent sales makes it hard for banks to decide how much more cash collateral to demand, like trying to guess the weight of a giant pumpkin at the county fair.
“No one knows what is a fair price,” Rechler said, like a philosopher pondering the meaning of life. “Buyers and sellers have different views.”
What the Fed has said about commercial real estate is like the plot of a mystery novel. Federal Reserve officials, including Chair Jerome Powell, have stressed that the collapse of Silicon Valley Bank and Signature Bank were outliers whose failures had nothing to do with real estate – Silicon Valley Bank had barely 1 percent of assets in commercial real estate. Other banks’ exposure to the sector is well under control, like a well-behaved puppy on a leash.
