From the Big D and Mini Apple to the Big Apple and La La Land, offices are emptier than a ghost town, proving that the work-from-home era is stickier than gum on a hot sidewalk. But clear desks and silent snack rooms aren’t just a migraine for bosses who want to corral their teams in the flesh.
Investors and regulators, spooked like Scooby-Doo after recent bank failures, are now sniffing around the downturn in the 20-gazillion-dollar US commercial real estate market. Right when lenders are struggling with the chaos of rapidly rising interest rates, the value of buildings like offices is going down as fast as a roller coaster ride. This could make banks cry ouchies and raise concerns about nasty ripple effects.
“Although this isn’t a Godzilla-sized problem for the banking sector yet, there are legit worries about this cold spreading,” said Eswar Prasad, a swanky economics professor at Cornell University.
In the doomsday scenario, nail-biting over bank lending to commercial real estate could spiral, causing customers to yank their deposits like it’s going out of style. It was this very nightmare of a bank run that knocked Silicon Valley Bank out cold last month, shaking up financial markets and raising fears of a party-pooping recession in the US of A.
When asked about the danger posed by commercial real estate, Federal Reserve Chair Jerome Powell said last month that banks were “strong” and “resilient,” like they’d been hitting the gym. But folks are keeping an eye on the ties between US lenders and the property world.
“We’re watching it like hawks,” said Michael Reynolds, vice president of investment strategy at Glenmede, a wealth manager. While he doesn’t think office loans will spell mischief for all banks, “one or two” institutions might end up with egg on their faces.
Even America’s head banker, JPMorgan Chase (JPM) CEO Jamie Dimon, couldn’t tell CNN for sure whether more banks would crash and burn this year. But he quickly added that the current sitch is nothing like the 2008 financial apocalypse, when there were more overleveraged institutions than you could shake a stick at.
The US market might be the weakest link, but The European Central Bank and Bank of England have also recently waved red flags about risks connected to commercial real estate as the future for prices looks gloomier than a rainy day.
The work-from-home bill has arrived, and commercial real estate, which includes everything from offices to apartments, from storage spaces to shopping centers, has been sweating bullets lately. Prices in the US went down 15% in March from their recent high, says data-provider Green Street. That quick hike in interest rates really hurt, since buying commercial buildings usually involves massive loans.
Office buildings—where all the work-from-home action is at—are the hardest hit on this rough ride. The hybrid work craze has put the squeeze on the rents many property owners can charge. Office occupancy in the US is still less than half of March 2020 levels, says security provider Kastle.
“It’s like you’ve got a double whammy: building owners feeling the heat from work-from-home trends and lending drying up like a raisin in the sun,” said Rich Hill, head honcho of real estate strategy at Cohen & Steers. “These two factors will lead prices to do a nose-dive.”
When the economy goes from running like a cheetah to walking like a turtle, the real estate troubles might grow. Hill thinks US commercial property prices could tumble about 20%-25% this year. For offices, the fall could be even more dramatic—maybe over 30%.
Now Matt Anderson, managing director at Trepp, a company that provides commercial real estate data, says he’s “more worried than he’s been in forever.”
Tensions are rising, just like those payments on commercial office mortgages that borrowers are falling behind on. The news is littered with tales of high-profile defaults, like when a landlord owned by asset manager PIMCO didn’t pay nearly $2 billion for seven offices in hefty cities like San Fran, New York City, Beantown, and Jersey City.
This is a potential ouchie for banks since they’re lending so much moolah to the sector. Goldman Sachs believes that 55% of US office loans are piling up on bank balance sheets. Already stressed-out regional and community banks account for a rockin’ 23% of the total.
Signature Bank (SBNY) had the tenth beefiest portfolio of commercial real estate loans in the US at the beginning of the year, while poor little First Republic (FRC), which just got a $30 billion life jacket last month from Jamie Dimon and his pals, had the ninth largest. But both banks had way more skin in the real estate game than bigger players like Wells Fargo (WFC), the top US lender to the sector.
Skyrocketing commercial property prices over the past decade have given developers and bankers a bit of a cushion, but the boo-boos might multiply in the coming months.
Banks are bracing for about $270 billion in commercial real estate loans to come due in 2023, with office properties accounting for nearly a third of that. Sinking valuations might make refinancing these loans tougher for property owners, who could face requests to cough up more cash from banks. Faced with this situation, some owners could decide to throw in the towel and hand over the keys.
Banks might pick that option over starting long, pricey foreclosure processes. But then they’ll find themselves knee-deep in properties with shrinking values.
“We’re gonna see this movie play over and over,” said Christian Ulbrich, CEO of giant commercial real estate services firm Jones Lang LaSalle (JLL). The real question is how lenders will react, and whether banks are hoarding such huge loan portfolios that they’ll have to swallow some “super-sized losses.”
Banks don’t have as much wiggle room to handle financial punches these days. Smaller banks are duking it out for deposits with bigger competitors and money-market funds that offer better returns. Plus, they’re now taking hits from investments in government bonds that used to be low-risk before interest rates bolted up.
In the suckiest scenario, a “doom loop” could develop, says Neil Shearing, chief economist at Capital Economics. Doubts about the health of banks with mega exposures to commercial real estate loans might scare customers into pulling deposits. That forces banks to demand repayment, deepening the sector’s blues and adding to the banks’ money woes. And so the vicious cycle goes.
But that’s not everyone’s bet, at least for now. Banks have learned their lesson from the 2008 financial crisis, beefing up lending standards and diversifying their clientele. Office loans make up less than 5% of total US bank loans, says UBS. Even JLL’s Ulbrich thinks commercial real estate can stomach the current interest rate pressure since it’s done so before.
“Let’s not jinx it, but I think we’ll be able to digest this,” Ulbrich said.
Most folks think there will be more defaults and less funding for the commercial real estate industry. Banks are expected to weather this storm, even if their earnings get pummeled.
That doesn’t mean, however, that others won’t get splashed.
“Distress like this doesn’t just rain on the parade of landlords and the bankers who lend them money,” said Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, in a note to clients this month. Non-bank lenders and related businesses and investors also might get soaked.
