Episode 13 | Is Commercial Real Estate The Next Shoe to Drop?

Episode 13 May 15, 2023 00:07:41
Episode 13 | Is Commercial Real Estate The Next Shoe to Drop?
LPC - Lending Lowdown Series
Episode 13 | Is Commercial Real Estate The Next Shoe to Drop?

May 15 2023 | 00:07:41

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Show Notes

High interest rates and falling property prices are causing turmoil in the commercial real estate market. The remote work situation is adding to fears about a shrinking demand for office space. With defaults on the rise and loans moving to special workouts, Fed policymakers and investors are worried the growing problems in the real estate market is a contagion for the US banking system. Host CJ Doherty discusses the issues with IFR Senior Reporter Richard Leong.   

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Episode Transcript

Speaker 1 00:00:13 Welcome to the Lending Luan. I'm CJ Doherty, director of analysis at Refinitiv LP C, and today we're pivoting to another part of the lending market, the commercial property market, which has been grabbing headlines and raising concerns among policymakers and investors. And most recently, Berkshire Hathaway, vice Chair Charlie Munger, issued a warning about the US commercial property market saying banks were full of bad loans. Overall, the market is roughly five and a half trillion in size, so very significant. And the environment has changed with less demand for office space, given more work from home these days. And higher interest rates is also among the factors impacting the market. So it's something we want to delve more into. And to do that, I'm happy to be joined by Richard Leon, senior reporter at our sister company I f r. Welcome, Richard. Thanks for joining me. Speaker 2 00:01:00 Great. Thank you for having me, cj. Speaker 1 00:01:02 Great. So, uh, to kick it off then, Richard, let's start broadly and, and can you set the stage and talk about the challenges that the commercial real estate market is facing? Speaker 2 00:01:10 There's quite a few. First of all, you have the biggest increase in interest rate here in the US in 40 years. Then you're seeing property prices starting to fall, um, roughly about 20%, but the fear is that, uh, they're gonna drop even more, uh, over the course of the next 12 to 18 months. And thirdly, and probably the most uncertain risk that the market is facing is about remote work. We just don't know right now how this is gonna impact long-term demand for office space, uh, here in the US and even around the world. Speaker 1 00:01:42 Okay, great. And, and, and to what degree have these pressures intensified after the collapse of, you know, Silicon Valley Banks, signature Bank and First Republic? How exposed are banks? So let Speaker 2 00:01:52 Me start off just to be clear, that the collapse of those banks had nothing to do with commercial real estate. They had to do with deposit ones because of the customer base and losses on investment because of the huge jump in interest rates. But it is, uh, leading, uh, the market to speculate whether the losses from bank's exposure to commercial real estate, especially regional ones, uh, and whether commercial real estate is really the next big shoe to drop, uh, for the market and for the banking system. So overall bank have a pretty right range of commercial real estate exposure. You have some that have very little to ones that have as much as 20, 30% depending on the size, which is quite sizable. And that's what's causing concerns in the market right now. Speaker 1 00:02:38 Okay. And, and so against this backdrop that you described, you know, to what extent are lending standards tightening and banks pulling back? I know if we look at some definitive data, uh, U S C MBS issuance slowed to roughly 14 billion in the first quarter of this year, and that was actually the lowest quarterly volume since 2012. Speaker 2 00:02:57 That drop in volume is a reflection of what we're seeing in the tightening of lending standards. Banks are essentially demanding, um, more cash from, uh, from the borrowers and also, uh, for the banks to just, uh, demand, uh, higher compensation for the loans that they're making. Um, borrowers themselves are quite reluctant at this point, uh, some of them to, um, make that commitment because they just don't know whether the properties that they own right now is gonna be worth anywhere near the, uh, price that they pay for just several years ago. Speaker 1 00:03:33 Okay. So, so given what you've kind of described there, I'd like to, to uh, delve a little bit more into the level of pressure in the market these days. What are you seeing in terms of delinquencies and to what extent have we seen downgrades in CM b s recently and and to what extent are downgrades set to continue? Speaker 2 00:03:52 Um, delinquency levels are definitely on the rise, but on a historical basis they're still very low. Even a problem sector like office right now is still fairly low based on the recent data from, uh, different firms, they're roughly about 2%, which on historical level, they're still quite low. But again, uh, the market is looking at the trajectory of these delinquencies and you are seeing some of the rating agencies responding by putting some of these deals on what they call credit watch. So they are up there for possible downgrades, and the expectation is that a lot more of these deals might be on these watch list for possible downgrades. Speaker 1 00:04:34 Okay. Definitely worth, uh, keeping, keeping monitoring that. And, and I wanna stay on the topic of stress in the market. You know, there have been some major defaults in the commercial real estate sector in the past year. Can you provide some names and context here? Speaker 2 00:04:48 I think two of the biggest name that really grabbed the attention of the market are two of the biggest private equity funds in the world, which are Blackstone and Brookfield. Um, Plex Stone in particular here, um, in Manhattan for instance, uh, where I work, uh, they did, uh, default on the loan on a big midtown Manhattan office building. So that started grabbing the market's attention and Brookville this year have defaulted on, uh, a couple of office property in LA and that's also causing, uh, quite a bit of a stir and concern in the market that, uh, you have big deep pocket investor that have bought a lot of money into this sector and now they are just defaulting on the loans. Speaker 1 00:05:36 Okay, great. And, and, and so, um, you know, a lot of the, the, the information you've provided here today, you know, we've touched on a lot of the negativity around the commercial real estate market recently, but before we wrap up, I wanna get your opinion on whether you see opportunities in this environment too. Speaker 2 00:05:54 I think they're definitely one sector of the investment community that are looking at, uh, bargain hunting are looking at whether, uh, these properties, once they become distressed and perhaps, uh, they have to be offloaded through some kind of even fire sale, whether they could pick up these, uh, properties at a bargain price in hopes that, uh, they can work out their problems with tenants. Uh, or the fact that, uh, essentially they could ride out the real estate, um, and interest rate cycle that way and right now and the property values are going to go up and they could profit from it. So that's definitely one of the area in which, uh, some part of the, uh, investor community is looking at to maybe, um, make some money, uh, from the downturn that we are seeing all the stress that we're seeing in the market. Speaker 1 00:06:42 Okay, great, Richard, and on that note, we'll wrap up for today and we'll certainly be keeping a close eye on the commercial property market in the coming months to see how things play out. Richard, thanks very much for sharing your insights with us. And thank you all for tuning in. I invite you to check out if R'S coverage on the commercial property market and indeed the broader capital [email protected] and follow them on Twitter at iffr tweets. I'm CJ Doherty. Subscribe to the lending lowdown on your favorite podcast platform. Speaker 3 00:07:13 When you contribute your fixed income deals to Refinitiv, they'll reach over half a million buy and sell side professionals around the world and be included in our industry leading league table rankings. To ensure we're capturing your entire deal flow, visit contribute.refinitiv.com/fi signup or contact our [email protected]. Make your deal count.

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