Wall Street braces for commercial real estate timebomb

Federal Reserve Chairman Jerome Powell’s comments last week about a rash of upcoming bank failures related to the struggling commercial real estate sector shocked the financial world, sending some investors fleeing to insurance and leaving others vulnerable. is looking for an opportunity.

Typical commercial leases in the U.S. are three to five years, but as remote work becomes more prevalent and urban land use changes accelerate, time is running out for office and commercial property owners and their financial sector creditors. is rapidly approaching.

Office vacancy rates, which had been steadily declining for a decade, rose sharply in the wake of the pandemic, hitting a record high of 13.1% last year, according to Treasury data. Financial Stability Oversight Council (FSOC) This was reported by analysis company Costar.

“As of midway through the third quarter of 2023, the domestic office vacancy rate hit an all-time high of 13.2%, 370 basis points higher than at the end of 2019,” said CoStar analyst Phil Mobley. mentioned in the third quarter analysis.

“The recent reset in office demand is shaking up the US market,” he added.

Private equity firm KKR’s Real Estate Finance Trust, which invests in real estate with funds from commercial mortgages, saw its stock price plummet in early February following news that it would cut its dividend due to losses on office loans. This is a recent example where a quarter of the population was lost.

Although delinquency rates for commercial mortgage-backed securities have been trending upward in recent months, they remain well below the highs reached in the aftermath of the pandemic and the 2008 financial crisis.

The Treasury Department’s latest FSOC report states that “the decline in demand for office real estate may take some time to stabilize as tenants make remote work decisions and adjust the amount of space they require.” Says. “Furthermore, a delayed return to office centers in densely populated urban areas could reduce demand for office properties there, as well as nearby retail space.”

Mr. Powell delivered a similar message to the Senate Banking Committee last week, going so far as to declare that failures would occur among small and medium-sized regional banks that make commercial real estate loans.

“I think this is an issue that we’re going to be dealing with for many more years. There will also be bank failures,” he said.

“This is not a primary problem for any very large bank. It’s the small and medium-sized banks that are having these problems. We’re working with them. We’re getting through it. It’s manageable. I think that’s the word I want to use,” Powell said.

Investors have heeded Mr. Powell’s warnings about the sector, but they are also taking them with a grain of salt, as traditional liquidity crises like the one that brought down Silicon Valley Bank and Signature Bank last year are likely to lead to losses. It is argued that the possibility of this happening is low.

“I think Chairman Powell was a little short-sighted,” Dan Alpert, managing partner at Westwood Capital, told The Hill. “There’s going to be chaos. I believe how these banks resolve with the help of government and outside capital is going to be very different than what we saw with the three banks. [last year] And certainly the same as we’ve seen in other crises. ”

He added that pressure on banks from commercial real estate exposure will not “happen overnight” and described the situation as a “slow train wreck” that will take time to revalue asset prices.

Still, short sellers are moving quickly to capitalize on the miscalculation.

One investment plan for real estate investment trusts (REITs) presented in The Hill aims to take advantage of bulging REIT balance sheets before asset values ​​erode due to rising interest rates and delayed rent increases. There is.

The proposal said the REIT’s assets would be revalued “in a relatively short period of time.”

Whether banks fail as a result of real estate losses, prompting new government intervention like the Fed’s credit line for the financial industry last year, may not be the biggest economic question arising from the tight office and retail real. No estate.

Rather, the long-term effects on commercial construction and land use in U.S. urban centers may be the most salient macroeconomic issue facing policymakers as a result of increased remote work.

“We’re not going to see a lot of commercial construction in the economy for 10 or 20 years,” Alpert said. “This is a big negative from a macro level.”

commercial real estate loans Construction and land development have tapered off in recent months after surging during the pandemic recovery and appear to be nearing the peak of the cycle.

total construction expenditure Although prices have fallen slightly in recent months after hitting post-pandemic highs, recent large investments in manufacturing construction could fill the void left by office projects.

Experts told The Hill that work is also underway in many parts of the country to repurpose vacant offices and redesign downtown business districts in response to reduced demand for in-person work.

“There are some bright spots in terms of land use changes in the commercial real estate market,” said Alice Shea, a city planner in Breaux-Happold Cities, New York.

“COVID-19 has really changed our view of how cities operate and where their centers of gravity are. In New York City, the suburban boroughs have really flourished with people working from home. , spending money in local neighborhoods.”

Although fully remote work has become less popular in the years since the pandemic made remote work mandatory, the benefits of hybrid work appear to be here to stay.

About 28% of paid workdays in the United States were worked from home in February, down from more than 60% at the height of the pandemic, but four times the pre-pandemic level, state news agencies said. Survey on work styles and awareness Graduated from Stanford University.

Notably, the prevalence of remote work in researchers’ data appears to be stabilizing at current levels.

“The pandemic has led to a permanent increase in telecommuting,” they note in multiple versions of the study.

A 2023 survey by pollster Pew found that 35% of workers who are able to work remotely choose to work remotely all the time. That’s up from 7% before the pandemic, but down from a peak of 55% in 2020.

Labor productivity of workers It seems to have normalized With the change in trends towards remote work. After spiking along with many other economic indicators during the post-pandemic recovery, productivity moderated, then rose again and is now in line with long-term trends.