Note: This is not investment advice.
Martin Selig owes $800 million. He can’t pay.
The major Seattle real estate developer is defaulting on a $379 million loan tied to 9 downtown office buildings, according to the Seattle Times. Selig has defaulted on several other large loans recently, totaling over $800 million.
The Maturity Wall
Selig is not alone. The national office vacancy rate cracked 20% earlier this year for the first time on record.
Commercial real estate loans aren’t like your usual, 30 year mortgage.
CRE loans last an average of just 7 years. When the 7 years is up, you refinance the property with a new loan.
A “maturity wall” of over $1 trillion worth of loans is coming due between now and 2027. Property owners will have to refinance their properties at much higher interest rates.
A higher rate means a higher payment. Meanwhile, income from their properties is declining due to vacancies, especially in the office market.
Why This Isn’t 2008
This weekend, a post on CRE defaults went viral on X:
This post has over 300,000 views, but it’s a little misleading.
The author compares the value of all CRE loans coming due over the next 2 years to the value of subprime residential mortgages leading up to the 2008 financial crisis. But this isn’t comparing apples to apples.
Porter is comparing all CRE loans to subprime residential specifically. The apples to apples comparison would be poor quality CRE loans to poor quality residential ones.
Extend and Pretend
The picture isn’t quite as ugly as Porter says. But it’s bad enough — there will be many more defaults like Selig’s.
I expect lenders to “extend and pretend.”
Banks love to do this. They extend the duration of the loan to avoid taking an upfront loss.
But when you extend loans on bad assets at below-market interest rates, you’re losing money anyway. You’re just not coming clean about it.
When banks extend and pretend, they often don’t take a loss on their books. That can help keep investors off their back, not to mention regulators.
But it doesn’t change the facts: there’s a half empty office building and a loan the borrower can’t pay.
Muddling Through
My prediction is that everyone will muddle through. Here’s how it could work:
1) Banks extend the loan durations
2) Property owners find some new tenants, especially as some companies return to office
3) Everyone makes less money for a while
4) The Fed keeps cutting rates
5) Most lenders and property owners avoid catastrophic losses
Despite the bad CRE loans, American banks are well capitalized right now. They can afford to take some losses, so long as those losses aren’t catastrophic.
Wrap-Up
When we see the problems in CRE, our brains jump straight to 2008. But history does not repeat itself.
These CRE problems are different.
Today’s defaults are more driven by temporary interest rate changes. What’s more, the office market is much smaller than the residential real estate market.
We’re going to see some gnarly losses. But don’t expect another 2008.
What do you think is next in commercial real estate?
Note: This is not investment advice.
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