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Tag: Commercial and office real estate brokers

  • The commercial real estate recovery is on, but the rebound may be uneven

    The commercial real estate recovery is on, but the rebound may be uneven

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    A commercial building available for rent in Melville, New York, April 17, 2023.

    Howard Schnapp | Newsday | Getty Images

    The tide could be turning for commercial real estate.

    The Federal Reserve began its interest rate cutting cycle in September, lowering the Fed funds rate for the first time since 2020 by 50 basis points, while hinting that more cuts are on the horizon. That could give interest rate-sensitive sectors such as commercial real estate long-awaited positive momentum.

    Lower interest rates make debt cheaper, helping to accelerate deal flow in an industry where deal activity had stalled into the second quarter of 2024. The CRE market had been pressured in the years after the initial Covid shutdowns, ending a nearly 15-year bull run in the face of higher borrowing costs, weak tenant demand and increased property supply. As a result, property values and sales declined.

    The Fed’s shift in policy is “the most notable green shoot” for the CRE market, Wells Fargo analysts wrote in a Sept. 3 research note. While lower rates are not a “magic bullet,” the easing of the Fed’s monetary policy “lays the groundwork for a commercial real estate recovery,” analysts wrote in a follow-up report in late September.

    For higher dividend-paying stocks such as REITs, lower rates make these fixed-income investments more attractive for investors. But the primary impact of interest rate cuts is psychological, according to Alan Todd, head of commercial mortgage-backed security strategy at Bank of America.

    “Once the Fed starts to cut, they’ll continue along that path,” which fosters a sense of stability, Todd said. As the market feels more comfortable, it will “incentivize borrowers to get off the sideline and start to transact.”

    CRE sales recovery

    Refinancing and sales volumes are already picking up as sentiment around the sector improves, according to Willy Walker, CEO of CRE financing firm Walker & Dunlop, in an interview with CNBC in late September.

    During the Fed’s tightening cycle, rising rates caused a standoff between buyers and sellers where buyers hoped for lower prices while sellers clung to inflated valuations. This stalemate froze the deal market, prompting investors to adopt a wait-and-see mindset, leaving many to wonder what’s next for the market.

    But more recently, overall transaction volumes saw their first quarterly increase since 2022 in the second quarter of 2024, driven by sales in the multifamily sector, analysts noted.

    More than $40 billion in transactions occurred during the second quarter, a 13.9% jump quarter over quarter, but still 9.4% lower year over year, according to real estate data intelligence firm Altus Group.

    With deals ticking up and supply coming down, property valuations appear be improving as the MSCI U.S. REIT Index showed a steady increase since the spring into September, Wells Fargo analysts noted in their Sept. 25 research.

    While these dynamics could set the stage for a broader recovery, with some major subsectors such as commercial retail real estate picking up in tandem, the path forward will likely be uneven.

    Headwinds in office

    The office sector of the CRE market continues to face a number of challenges, despite some signs of modest improvement in the second quarter.

    Wells Fargo reported that for the first time since 2022, office net absorption — an industry metric used to determine the change in occupied space — turned positive, with over 2 million square feet taken up during the three-month period.

    “Although modest, this was the best outturn since Q4-2021,” according to analysts. However, this small victory wasn’t enough to offset rising vacancies, as supply continued to outpace demand for the 10th consecutive quarter, pushing the availability rate to a new high of 16.7%.

    In major cities such as Manhattan, office buildings in June had an average visitation rate of 77% of 2019 levels — the highest monthly total since the Real Estate Board of New York began tracking in February 2023.

    Still, Wells Fargo analysts point out that “the headwinds still greatly outnumber the tailwinds,” with hybrid work and a downshift in office job growth continuing to weigh on demand.

    Prices remain below pre-pandemic levels, with central business district office prices down 48.7% since 2019, according to the analysts.

    Beyond the temporary disruption of remote work, there are “structural challenges” that have intensified the industry’s difficulties since the pandemic, including low demand, soaring vacancies and flat rents, according to Chad Littell, national director of U.S. Capital Markets Analytics at CoStar Group.

    “Recovery looks distant,” for the CRE office sector, Littell said. “While other property types are finding their footing, office may have a longer road ahead — perhaps another year or more before prices stabilize.”

    Multifamily strength

    Multifamily real estate assets, on the other hand, have experienced an uptick in demand, with net absorption reaching their highest level in almost three years during the second quarter, according to Wells Fargo’s research.

    That’s true even as construction of multifamily housing booms, with completed units on track to exceed a record 500,000 this year, according to data from RentCafe. By the end of 2024, developers are set to complete more than 518,000 rental units.

    The multifamily sector was a pandemic darling within CRE as rent growth hit double digits in 2021. But that growth rate has since slowed to around 1%.

    Yet this increase in demand suggests a shift in consumer behavior, as “households are taking advantage of greater apartment availability, generous concessions and more manageable rent growth,” Wells Fargo said.

    Among the factors pushing renters to multifamily is a lack of affordable single-family homes for entry level. This trend is underscored by the stark contrast between homeownership costs and rental expenses: The average monthly mortgage payment reached $2,248 during the second quarter, 31% higher than the average monthly apartment rent of $1,712, Wells Fargo said.

    Multifamily is also benefiting from stabilizing vacancy rates. For the first time in over two years, vacancies didn’t rise during the second quarter, holding steady at 7.8%. This stabilization, combined with the 1.1% average increase in rent, indicates a healthier balance between supply and demand.

    Looking ahead, the outlook for the multifamily sector remains positive.

    Wells Fargo analysis suggested that “high homeownership costs should continue to support rent demand,” meaning that current trends favoring multifamily housing are likely to persist in the near term.

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  • Bullish on credit across the board with strength in economy and earnings: Marathon Asset’s Richards

    Bullish on credit across the board with strength in economy and earnings: Marathon Asset’s Richards

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    Bruce Richards, Marathon Asset Management CEO, joins ‘Money Movers’ to discuss what opportunities have opened up now that the Fed has cut rates, where Richards is more bullish on credit, and much more.

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  • Why hundreds of U.S. banks may be at risk of failure

    Why hundreds of U.S. banks may be at risk of failure

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    Hundreds of small and regional banks across the U.S. are feeling stressed.

    “You could see some banks either fail or at least, you know, dip below their minimum capital requirements,” Christopher Wolfe, managing director and head of North American banks at Fitch Ratings, told CNBC.

    Consulting firm Klaros Group analyzed about 4,000 U.S. banks and found 282 banks face the dual threat of commercial real estate loans and potential losses tied to higher interest rates.

    The majority of those banks are smaller lenders with less than $10 billion in assets.

    “Most of these banks aren’t insolvent or even close to insolvent. They’re just stressed,” Brian Graham, co-founder and partner at Klaros Group, told CNBC. “That means there’ll be fewer bank failures. But it doesn’t mean that communities and customers don’t get hurt by that stress.”

    Graham noted that communities would likely be affected in ways that are more subtle than closures or failures, but by the banks choosing not to invest in such things as new branches, technological innovations or new staff.

    For individuals, the consequences of small bank failures are more indirect.

    “Directly, it’s no consequence if they’re below the insured deposit limits, which are quite high now [at] $250,000,” Sheila Bair, former chair of the U.S. Federal Deposit Insurance Corp., told CNBC.

    If a failing bank is insured by the FDIC, all depositors will be paid “up to at least $250,000 per depositor, per FDIC-insured bank, per ownership category.”

    Watch the video to learn more about the risk of commercial real estate, the role of interest rates on unrealized losses and what it may take to relieve stress on banks — from regulation to mergers and acquisitions.

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  • Why the Fed expects more bank failures

    Why the Fed expects more bank failures

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    Of about 4,000 U.S. banks analyzed by the Klaros Group, 282 banks face stress from commercial real estate exposure and higher interest rates. The majority of those banks are categorized as small banks with less than $10 billion in assets. “Most of these banks aren’t insolvent or even close to insolvent. They’re just stressed,” Brian Graham, Klaros co-founder and partner at Klaros. “That means there’ll be fewer bank failures. But it doesn’t mean that communities and customers don’t get hurt.”

    14:18

    Wed, May 1 202410:05 AM EDT

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  • The looming office space real estate shortage. Yes, shortage

    The looming office space real estate shortage. Yes, shortage

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    Visoot Uthairam | Moment | Getty Images

    There is more pain to come in the office real estate market across the U.S., with maturing debt needing to be refinanced and a wave of expiring leases, but there is also what may seem at first brush to be a counter-intuitive message being sent to top tier companies by real estate intelligence company CoStar Group: prepare for an office space shortage.

    You read that right: amid a commercial real estate market across U.S. downtowns being described in apocalyptic terms, CoStar sees a shortage on the horizon, with one key caveat for top companies to bear in mind.

    The more office real estate that disappears – an estimate recently given to CNBC by the CEO of major bondholder TCW Group forecasts up to one-third of office real estate still to be wiped out – the more the major players in the market will be vying for the top tier of Class A commercial space. Add to that the fact that more companies are headed back to an in-office reality closer to pre-pandemic expectations, and competition may be hotter than the weaker end of the market suggests.

    CoStar’s call of an upcoming office space shortage is predicated on a look at the current data on leasing and construction activity compared to recent market history. As office occupiers scrutinize their footprints more carefully, and in the months ahead leases that were executed before the pandemic continue to approach expiration, newly constructed buildings aged 0-3 years are proving to be the winners. They have attracted over 175 million square feet of net new occupancy since the beginning of 2020, an average of 12.7 million square feet per quarter. By comparison, the quarterly average from 2011-2019 for similar properties was 11.7 million square feet. From 2008-2010, during the Great Recession, the quarterly average was 13.6 million square feet.

    “Modern, premium office space remains in demand, just as it has historically, even during difficult economic times,” said Phil Mobley, national director of office analytics at CoStar Group.

    Google’s mixed-use campus on New York’s Hudson River that opened in 2022 includes a two-acre rooftop and public gathering spaces.

    Photos courtesy of Google

    And the supply will increasingly not be there to support the demand. Currently, buildings aged 0-3 years comprise 2.4% of office inventory in the U.S. While that is in line with the average from 2015-2019, Mobley says construction has slowed dramatically. Less than 30 million square feet has broken ground in 2023, making this year the lowest for construction starts since 2011. Today, there is about 200 million square feet of office space in buildings aged 0-3 years, but that figure will be under 150 million by early 2026 and under 100 million by the middle of 2027. At that point, it will represent only about 1% of inventory. Even in the aftermath of the Great Recession in 2013-2014, buildings aged 0-3 years never represented less than 1.3% of inventory.

    “The very type of space that tenants have historically demanded most — even during recessions — will be in short supply,” Mobley said.

    This isn’t to say there won’t be more headlines about trophy buildings being sold at discounted values. But those transactions also mean that now is a time when tenants are getting good deals. The number of new lease transactions is higher this year on a quarterly basis than the 2015-2019 period. Deals are smaller in square footage – which explains why overall market vacancy is up – and expiring leases are part of the reason for the uptick, too. Still, the deals are “highly concentrated” in the premium space, Mobley said.

    Meanwhile, landlords of iconic, trophy buildings are offering sweeteners, from bigger contributions to custom buildouts to the number of months offered rent-free. It’s not clear how long that will last, though. As more top buildings are sold at depressed values, investors mark down the value of property holdings, and bonds go bad, new owners can make their finances work with attractive terms to tenants. But for building owners who will need to refinance in the near-term, that game is ending. Case in point: a recent deal for the City of Los Angeles to occupy multiple floors in the iconic Gas Co. Tower, a deal which would have comprised 11% of new quarterly leasing activity in the market, was rejected by bondholders.

    Billionaire real estate investor Jeff Greene explained his bet on new towers in West Palm Beach, amid the correction he sees coming for much commercial real estate in the next two years, in the following way during a recent CNBC interview: “There will just be office buildings with no tenants whatsoever in markets where brand new building will get the tenants. … Some of the older buildings just won’t have any tenants at all, and if there’s no tenant at all for a prolonged period of time, that paper [the bonds] will be worth next to nothing.”

    The U.S. housing market never recovered from the financial crash as measured by the inventory levels today, one factor responsible for pushing up home values across the country. But Mobley says there is a better parallel for the office space crash: the retail washout, which was overbuilt, and has not been built much since e-commerce disrupted the sector. While Class B malls are still sitting vacant, high-end “experiential” retail is not.

    “That’s the parallel for office,” Mobley said.

    CoStar estimates there is still over half of leases executed before 2020 set to expire. “As companies face these renewal decisions, they are now laser-focused on utilization,” he said. That implies a world in which tenants may need less space, but as they continue to make the case for the world of work to return to pre-pandemic in-person collaboration, competition for the best square footage in the market is heading higher.

    For companies facing lease expirations that believe in the notion of the office as a tool to help maximize workforce effectiveness and, as a result, want to be in premium locations  — and not the 10-20 year-old iconic buildings but the newest properties – some of the best opportunities are now, Mobley said.

    Billionaire investor Jeff Greene: We're in the first inning of the commercial real estate correction

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  • How Wall Street’s REIT giants are reshaping U.S. real estate

    How Wall Street’s REIT giants are reshaping U.S. real estate

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    U.S real estate investment trusts today manage $4.5 trillion in real estate worldwide. Many groups on Wall Street offer these tax-friendly funds to retail investors. 

    KKR’s real estate business is one of the big players in the REIT game. The private equity firm manages multiple REIT funds. The KKR Real Estate Select Trust, which currently manages $1.5 billion in assets, paid a dividend of 5.4% to its investors in July 2023.

    But the benefits extend beyond returns.

    “When you look at the after tax equivalent of that yield, it is very compelling.” said Billy Butcher, CEO of KKR’s global real estate business. “The depreciation from our properties has covered 100% of the income generated by our properties, and there’s no tax on that dividend,” he said in an interview with CNBC.

    Larger funds sometimes contain a diversified pool of assets. Categories may include office, student housing, casino, timberlands, radio and cell towers, server farms, self-storage properties, billboards, and much more.

    “Back in the 1960s, there were three or four different types [of REITs], said Sher Hafeez, a managing director at Jones Lang LaSalle, a real estate services firm. “Now, I can count at least 20 different types.”

    Top performing REIT sub-sectors in recent years include data centers, self-storage properties, residential housing and tower REITs. Residential housing delivered a return of 16% from 2010 to 2020, according to a S&P Global Investments report.

    The investor-friendly tax rules can also increase the pace of large-scale development. 

    “Having REITs there as a potential exit helps the market, and helps the availability of financing,” said Michael Pestronk, CEO and co-founder of Post Brothers, a Philadelphia-based housing developer. 

    Some funds like Invitation Homes and American Homes 4 Rent were founded in the yearslong slowdown in U.S. home construction. At the time, REITs bought and managed commercial-scale properties, which could include products like master-planned communities or traditional apartment complexes.

    In recent years, publicly traded trusts have targeted single-family rental market, and today, these REITs have grown tremendously — enough to build new neighborhoods in their entirety. 

    Watch the video above to learn the fundamentals of real estate investment trusts.

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  • ‘Hurricane has landed:’ Activist investor Jonathan Litt doubles down on office space short

    ‘Hurricane has landed:’ Activist investor Jonathan Litt doubles down on office space short

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    A major activist investor is betting stalled return-to-office plans will stir up more trouble in commercial real estate.

    Land and Buildings’ Jonathan Litt has been shorting REITs with high office space exposure for three years, and he has no plans to shift gears.

    “If you have no rent growth and your vacancies are going up and you have giant operating expenses to run an office building, you’re going backwards fast,” the firm’s chief investment officer told CNBC’s “Fast Money” on Tuesday.

    Litt first warned Wall Street an “existential hurricane” was about to hit the sector in May 2020. Now, he’s saying the “hurricane has landed.”

    He’s doubling down on the call — citing spiking interest rates and high inflation. Litt calls them two factors he didn’t anticipate when he first started shorting these companies in May 2020.

    DC-based JBG Smith Properties is one of Litt’s major shorts. It’s down 58% since the World Health Organization declared Covid-19 as a pandemic on March 11, 2020. So far this year, JBG Smith is off 20%.

    “Washington, DC is one of the toughest markets in the country today,” noted Litt. “They have a substantial office portfolio.”

    He adds the crackdown on lending is compounding the problems.

    “This isn’t a work from home story anymore. This is a financing story. It’s kind of like them mall business went from the mall problem to the financing problem,” Litt said. “Now, it’s a financing problem. And as these debts come due, there’s really nowhere to go because lenders aren’t lending to the space.”

    JBG Smith did not immediately respond to a request for comment.

    Disclaimer

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  • The coming commercial real estate crash that may never happen

    The coming commercial real estate crash that may never happen

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    Richard Baker | In Pictures | Getty Images

    Only two months ago, SL Green & Co. chief executive Marc Holliday was sounding happy. The head of New York’s biggest commercial landlord firm told Wall Street analysts that traffic to the company’s buildings was picking up, and more than 1 million square feet of space was either recently leased or in negotiations. The company’s debt was down, it had finished the structure for its 1 Madison Avenue tower in Manhattan, and local officials had just completed an extension of commuter rail service from Long Island to Green’s flagship tower near Grand Central Station.

    “We are full guns blazing,” Holliday said on the quarterly earnings call, with workers headed back to offices after a pandemic that rocked developers as more people worked from home, raising the question of how much office space companies really need any more. “We can hopefully …continue on a path to what we think will be a pivot year for us in 2023.” 

    Then Silicon Valley Bank failed, and Wall Street panicked. 

    Shares of developers, and the banks that lend to them, dropped sharply, and bank shares have stayed low. Analysts raised concerns that developers might default on a big chunk of $3.1 trillion of U.S. commercial real estate loans Goldman Sachs says are outstanding. 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.

    How much an office crash could hurt the economy

    There are reasons to think the road ahead will be rocky for the real estate industry and banks that depend on it. And 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.

    “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. “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. 

    But this year’s refinancing cliff is the real rub, says Scott 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. 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, he said. And the shortage of recent sales makes it hard for banks to decide how much more cash collateral to demand.

    “No one knows what is a fair price,” Rechler said. “Buyers and sellers have different views.” 

    What the Fed has said about commercial real estate

    Federal Reserve officials up to and 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.

    “We’re well aware of the concentrations people have in commercial real estate,” Powell said at a March22 press conference. “I really don’t think it’s comparable to this. The banking system is strong, it is sound, it is resilient, it’s well capitalized.”

    The commercial real estate market is a bigger issue than a few banks which mismanaged risk in bond portfolios, and the deterioration in conditions for Class B office space will have wide-reaching economic impacts, including the tax base of municipalities across the country where empty offices remain a significant source of concern. 

    But there are reasons to believe lending issues in commercial real estate will be contained, Fagan said.

    The first is that the office sector is only one part of commercial real estate, albeit a large one, and the others are in unusually good shape.

    Vacancy rates in warehouse and industrial space nationally are low, according to Cushman and Wakefield. The national retail vacancy rates, despite the migration of shoppers to online shopping, is only 5.7%. And hotels are garnering record revenue per available room as both occupancy and prices surged post-Covid, according to research firm STR.  Banks’ commercial real estate lending also includes apartment complexes, with rental vacancies rates at 5.8 percent in Federal Reserve data.

    “Market conditions are fine today, but what develops over the next two to three years could be pretty challenging for some properties,” said Ken Leon, who follows REITs for CFRA Research.

    Still, most debt coming due in the next two years looks like it can be refinanced, Fagan said.

    That’s one of the reasons Rechler has been drawing attention to the issues. It shouldn’t sneak up on the market or economy, and it should be manageable with the loans spread out across their own maturity ladder.

    About three-fourths of commercial real estate debt generates enough income to pass banks’ recent refinancing standards without major changes, Fagan said. Banks have been extending credit using a rule of thumb that a property’s operating income will be at least 8% of the loan every year, though other experts claim a 10% test is being applied to some newer loans. 

    To date, banks have had virtually no losses on commercial real estate, and companies are showing little need to default either on loans to banks or rent payments to office building owners. Even as companies lay off workers, the concentration of job losses among big tech employers, in Manhattan, at least, means that tenants have no trouble paying their rent, S.L. Green said. 

    Bank commercial mortgage books

    Take Pittsburgh-based PNC Financial, or Cincinnati-based Fifth Third, two of the biggest regional banks.

    At PNC, the $36 billion in commercial mortgages on the books of the bank is a small fraction of its $557 billion in total assets, including $321.9 billion in loans. Only about $9 billion of loans are secured by office buildings. At Fifth Third, commercial real estate represents $10.3 billion of $207.5 billion in assets, including $119.3 billion in loans.

    And those loans are being paid as agreed. Only 0.6% of PNC’s loans are past due, with delinquencies lower among commercial loans. The proportion of delinquent loans fell by almost a third during 2022, the bank said in federal filings. At Fifth Third, only $10 million of commercial real estate loans were delinquent at year-end.

    Or take Wells Fargo, the nation’s largest commercial real estate lender, where credit metrics are excellent. Last year, Wells Fargo’s chargeoffs for commercial loans were .01 of 1 percent of the bank’s portfolio, according to the bank’s annual report. Writeoffs on consumer loans were 39 times higher. The bank’s internal assessment of each commercial mortgage’s loan’s quality improved in 2022, with the amount of debt classified as “criticized,” or with a higher-than-average risk of default even if borrowers haven’t missed payments, dropping by $1.8 billion to $11.3 billion

    “Delinquencies are still lower than pre-pandemic,” said Alexander Yokum, banking analyst at CFRA Research. “Any credit metric is still stronger than pre-pandemic.”

    Wall Street is worried

    The riposte from Wall Street is that the good news on loan performance can’t last – especially if there is a broader recession. 

    In a March 24 report, JPMorganChase bank analyst Kabir Caprihan warned that 21% of office loans are destined to go bad, with lenders losing an average of 41% of the loan principal on the failures. That produces potential writedowns of 8.6%, Caprihan said, with banks losing $38 billion on office mortgages. But it is far from certain that so many projects would fail, or why value declines would be so steep.

    RXR’s Rechler says that market softness is showing in refinancings already, in ways banks’ public reports don’t yet reveal. The real damage is showing up less in late loans than in the declining value of bonds backed by commercial mortgages, he said.  

    One sign of the tightening: RXR itself, which is financially strong, has advanced $1 billion to other developers whose banks are making them post more collateral as part of refinancing applications. Rechler dismissed rating agencies’ relatively sanguine view of commercial mortgage backed securities, arguing that markets for new CMBS issues have locked up in recent weeks and ratings agencies missed early signs of housing-market problems before 2008’s financial crisis. 

    The commercial mortgage-backed bond market is relatively small, so its short-term issues are not major drivers of the economy. Issuance of new bonds is down sharply – but that began last year, when fourth-quarter deal volume fell 88 percent, without causing a recession.

    CMBS issuance

    Loan type Q1 2022 Q1 2023
    Conduit $7.9B $2.3B
    SASB $19.1B $2.7B
    Large loan $442.6M $13.1M
    CRE CLO $15.3B $1.5B
    Total $42.8B $6.5B

    Source: Trepp

    “The statistics don’t reflect where it’s going to come out as regulators take a harder look,” Rechler said. “You’re going to have to rebalance loans on even good properties.” 

    Wells Fargo has tightened standards, saying it is demanding that payments on refinanced loans take up a smaller percentage of a building’s projected rent and that only “limited” exceptions will be made to the bank’s credit standards on new loans.

    Without a deep recession, though, it’s not clear how banks’ and insurance companies’ relatively diversified loan portfolios get into serious trouble. 

    The primary way real estate could cause problems for the economy is if an extended decline in the value of commercial mortgages made deposits flow out of banks, forcing them to crimp lending not just to developers but to all customers. In extreme cases, that could threaten the banks themselves. But if developers continue to pay their loans on time and manage refinancing risk, MBS owners and banks will simply get paid as loans mature. 

    Markets are split on whether any version of this will happen. The S&P United State REIT Index, which dropped almost 11% in the two weeks after Silicon Valley Bank failed, has recovered most of its losses, down 2% over the past month and remains barely positive for the year. But the KBW Regional Banking Index is down 14% in the last month, even though deposit loss has slowed to a trickle.

    The solution will lie in a combination of factors. The amount of loans that come up for refinancing drops sharply after this year, and new construction is already slowing as it does in most real estate downturns, and loan to value ratios in the industry are lower than in 2006 or 2007, before the last recession.

    “We feel like there’s going to be pain in the next year,” Fagan said. “2025 is where we see our pivot toward a [recovery] for office.”

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  • Companies still have way too much office space, and they can’t sell it

    Companies still have way too much office space, and they can’t sell it

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    Collin Madden, founding partner of GEM Real Estate Partners, walks through empty office space in a building they own that is up for sale in the South Lake Union neighborhood in Seattle, Washington, May 14, 2021.

    Karen Ducey | Reuters

    A few things we know about corporate real estate: it’s a focus of cost-cutting for companies, but it’s also probably the last asset you want to sell now in a soft market.

    How soft? According to Elizabeth Ptacek, senior director of market analytics at commercial real estate information and analytics company CoStar, there is currently 232 million square feet of surplus commercial real estate up for sub-leasing. To put those numbers into perspective, Amazon’s HQ2 is 8 million square feet. Even more telling, the 232 million square feet is twice the level of surplus from before the pandemic.

    CFOs have told us that as their companies go to hybrid work and corporate hub models that make less use, if any use, of satellite offices, there is real estate to be sold. And they aren’t selling it now. Ptacek says that’s the right decision.

    The only property owners selling today are either desperate for cash or they are sitting on trophy assets. And those trophy assets are few and far between. Well-leased medical offices and laboratories with high credit score tenants and secure income streams are still attracting plenty of attention from investors, according to CoStar, but that’s about it. Any corporation that has abandoned a satellite office that used to be key for its in-office staff, is sitting on a property that Ptacek says, “no one will buy for anything less than a substantial discount.”

    Between the shock to commercial real estate from the remote work trend, followed by the higher interest rates and the prospect of another recession, now is no time to sell even if Ptacek says commercial real estate owners should expect it will get worse yet. CoStar projects that the sub-leasing surplus will persist as companies worry about needing to lay off workers and make other cuts ahead of a recession, and it goes further: the subleasing square footage will never return to the pre-pandemic level, she said.

    The slowdown in investment activity that Ptacek described as a gradual slowdown so far, will become a “dramatic slowdown” after the pipeline of deals signed in Q2 and Q3 before rates started to rise are closed. “The bigger impact is ahead of us, and absolutely the higher borrowing cost will have an impact, and in many cases, eliminate the levered investors,” she said.

    It’s a bad situation, but she said that for owners of corporate real estate, if the cost of real estate debt is cheap and the balance sheet is solid, sit on the real estate.

    With companies still in the early days of their hybrid work experiments, it’s not just economic uncertainty but uncertainty about how in-office occupancy trends over time which should make companies want to hold off pulling the trigger on asset sales. Leases that were up for renewal were an easy call to make (end it), and firms can always sign new leases (likely at even better rates) if and when they need to make that call.

    “It’s all still shaking out and you see it, you see the big companies one day fully remote and the next day signing huge leases and telling everyone, ‘Back in the office,’ and then the minute they do employees express consternation and they say, ‘Never mind.’ It’s all very much in flux,” Ptacek said.

    Uncertainty is the ultimate deal killer, she said. No one wants to buy assets with the risk of no demand barring rent cuts of 50%. It’s difficult right now, she said, for either buyer or seller to reach what would be defined as a “reasonable price.”

    Companies should expect the situation may be even worse a year from now.

    “It’s probably a fair assumption that this is not going to be a lot better in a year, in terms of demand,” she said. “There could be another leg down in transactions.”

    The wave of distressed sales that usually occur in downturns have not occurred yet, and that is right on schedule, as they tend to lag the start of downturns by a few years. Ptacek noted that after 2008, the peak in the distressed asset sales wave didn’t occur until 2010/2011.

    “As loans come due and they have difficulty, it’s refinance or sell,” she said. And more borrowers won’t be able to refinance, and the wave of distressed sales will ensue. “There will likely be some level of distress which will weigh on pricing, so you could as an owner find yourself in a position in a few years where the environment is even less favorable. But it’s not like it’s a good environment today,” she said.

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