Fund managers are warning banks that the $5.6 trillion U.S. commercial real estate industry could experience defaults on mortgages, especially in major cities, the Financial Times reports.
“We’re likely going into a real estate recession, but not across the entire real estate market,” says Guggeinheim Partners Chief Investment Officer Anne Walsh. She predicts the worst pain will be concentrated in the biggest urban centers of the country, like New York and San Francisco, where many offices are still vacant.
Rising interest rates and falling prices are worsening the problem of finding tenants for office buildings still empty after the pandemic. These difficulties have intensified after the failures of Silicon Valley Bank, Signature Bank and First Republic brought attention to regional banks’ large commercial mortgage holdings.
‘Next Shoe to Drop’
“The private market hasn’t started to heavily mark down real estate,” says Scott Kleiman, co-president of Apollo Global Management. “The equity will be first. That’s the next shoe to drop in the U.S.,” rivaling the commercial real estate crisis of the 1990s.
“Like everything else, it has been priced so tightly,” Kleinman adds.
“Commercial real estate is leverage on leverage on leverage,” adds the CEO of a large U.S. bank speaking on condition of anonymity. “If people are forced to quickly unwind that leverage, it can quickly pop up in other places. There’s a maturity cliff for a lot of this real estate in the next few years—a significant portion of which is funded by regional banks.”
Real estate developers have had the benefit, for years, of borrowing very inexpensively while interest rates were low and they could invest in commercial properties, whose value appreciated.
“We see a perfect storm of rising interest rates forcing assets to reprice down, combined with a structural decline in occupation rates and ageing assets,” says Matthew Chabran, co-founder of alternative asset manager Tikehau Capital.
Walsh agrees that second-class office buildings in need of repair will also become problematic.
“Lenders will be very choosy about what loans they are willing to make,” Walsh says. Many are asking borrowers to put up personal assets as collateral.
Already in the first quarter, a Federal Reserve survey released Monday shows, banks tightened credit standards for non-residential properties.
Earlier this month, Berkshire Hathaway Vice Chairman Charlie Munger sounded the same warning, saying banks are loaded up with too many bad commercial loans.
“It’s not nearly as bad as it was in 2008—but trouble happens to banking just like trouble happens everywhere else,” Munger told the Financial Times.
“A lot of real estate isn’t so good anymore,” Munger said. “We have a lot of troubled office buildings, a lot of troubled shopping centers, a lot of troubled other properties. There’s a lot of agony out there.”
‘Extend and Pretend’
“Every bank in the country is way tighter on real estate loans today than they were six months ago,” Munger explained of why, in the case of the recent failures of Silicon Valley Bank, Signature Bank and First Republic Bank, that Berkshire has not dipped into its cash reserves of $100 billion-plus to pitch in.
At Berkshire’s annual shareholder meeting in Omaha, Nebraska, Saturday, CEO Warren Buffett put the commercial real estate and regional bank problem more succinctly:
“The banks tend to extend and pretend,” Buffett said. “There’s all kinds of activities that arise out of commercial real estate development that occur on a big scale, but it all has consequences, and we are starting to see the consequences of people who could borrow at 2.5% and find out it doesn’t work at current rates.”
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