“There are no buyers for empty office space at any price.” That’s a friend of mine who works in NYC commercial real estate. But landlords aren’t the only ones in deep trouble.
I’m writing this post from my living room. Chances are, you’re reading it at home too.
That means we’re not in offices. And as landlords survey their barren domain, things are getting desperate.
From a report out overnight in The Wall Street Journal:
“What we’re seeing is the unfortunate collision of the most rapid increase in interest rates in a one-year period and the realities of how people work,” said Gregg Williams, principal receiver at Trident Pacific, a receivership firm for defaulted commercial mortgages.
Xiaojing Li, managing director at data company CoStar’s risk analytics team, estimates that as much as 83% of outstanding securitized office loans won’t be able to refinance if interest rates stay at current levels.
CRE loans are nothing like residential mortgages.
Landlords make small payments during the life of the loan. The loan is usually for five to ten years, much shorter than a residential mortgage.
In recent years, most landlords have only had to pay the loan interest.
When the time is up, the landlord has to pay the entire value of the building. Since they don’t have that kind of cash laying around, they usually refinance or sell the property.
For a long time, this was a great playbook.
But now, interest rates have doubled. Moreover, work from home is entrenched, which could lead to long term vacancies in office towers.
So if you’re the landlord, what are your options?
You can’t refinance. The rates are so high that you can’t afford the payment.
And if you sell, you’ll get way less than what you owe on the loan.
So either the bank backs off, or you walk away from the building.
So far, the banks are playing ball.
Only some defaults end with the lender taking the keys. Often, property owners can stave off foreclosure by paying off loans with their own cash or by extending and renegotiating mortgages. Still, debt brokers and attorneys say lenders are less patient than they have been in the past.
What else can they do? They don’t want to own a bunch of aging, vacant office towers.
Making a deal with the landlord solves the problem — for now. But if the landlord can never repay what he borrowed, the banks are just hiding losses.
“The banks tend to extend and pretend.”
Warren Buffett, Berkshire Hathaway Annual Shareholder Meeting, May 2023
Bad real estate loans could sink regional banks. Smaller banks own 80% of these mortgages — $2.3 trillion.
If these loans go bad, it will make the banking crisis in March look like a tea party.
One bright spot: the office market in most cities is actually holding up.
Nationally, the vacancy rate is only up 3.7% from pre-Covid levels. The massive outlier here is San Francisco, with vacancies up 12.8%.
The banks at greatest risk from a CRE crisis will be regional banks with exposure to SF, LA, and NYC. One of the largest CRE lenders in New York, Signature Bank, already bit the dust in March.
Long term, I think office space nationwide is in serious trouble. The technology for remote work is getting better every day.
Soon, workers may join meetings from their couch on an Apple Vision Pro. The experience might be just as immersive as in-person without hours wasted commuting.
It’s a future I look forward to. But then, I’m not a landlord.
What does the future hold for CRE? Leave a comment and let us know!
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More on markets:
‘There’s a Lot of Agony Out There’: Munger on CRE
Carl Icahn Losing $900 Million a Day
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