Commercial Real Estate Implodes Across the News

February 13, 2024

In my weekend Deeper Dive (“Banks Breaking Bad”) I wrote about how the US commercial real-estate (CRE) crisis is spreading like cancer to banks around the world. I woke up from that today to find Monday’s news is flooded with stories about the global spread of the CRE crisis. Consider some of the following:

Fitch Ratings, one of the major credit-rating agencies, noted the following problems in Asia-Pacific banks:

Shanghai Commercial Bank Limited: “Higher exposure to the US market accounted for 29% of loans (12% of assets) in June 2023, but the bank does not disclose what share of this is CRE-related.”
China CITIC Bank International Limited: “US exposures accounted for around 5% of loans (2.7% of assets) but similarly this is not all CRE.”
Macquarie Group Limited (Australia) “May have US exposure above the average for Fitch-rated banks in APAC….”
“Some APAC financial institutions, including banks not rated by Fitch, potentially have US CRE exposure levels higher than the average for Fitch-rated APAC banks.”

The numbers are not terrible, but the trouble in CRE is “spread far and wide.” Perhaps, for US banks, the spread lessens some of the impact. However, another story today talks about the greater risk that is spreading to Europe, which I gave a little more time to in my Deeper Dive as well:

The banking-sector jitters that are rocking the likes of New York Community Bancorp will not be confined to the US, with the potential for defaults spreading to Europe, according to a top-performing fund manager.

“There are portions of the market that we think are in very deep trouble,” said Jonathan Golan, a portfolio manager at Man Group Plc in London, whose investment-grade bond fund beat 99% of peers last year in data compiled by Bloomberg. “You’ve got more banks that are coming under scrutiny, more banks falling casualty, and potentially some banks defaulting on both sides of the Atlantic.”

That doesn’t sound as benign as the Asian spread. That spread may lesson some of the impact in the US, too, since a lot of US CRE bonds are owned by foreign banks. On the other hand, broadening the spread of cancer does not sound like such a good thing either. We’re all globally connected, so when US CRE bonds fail and take down some banks in Europe, the failure of those banks bounces back to institutions here that may not be directly invested in CRE but had strong ties with those banks. And so the trouble keeps spreading insidiously.

“In Germany, Scandinavia, we are seeing commercial real estate exposure as percent of tangible equity in the 400, 500, 600, 700% range,” Golan said in an interview. “If each of these banks takes a 15 cents write down for every dollar they lend to commercial real estate — which I’m not saying is a base case, but is a completely reasonable scenario — not only are these banks not investment grade, they’re insolvent.”

Pretty powerful words about CRE bonds from an outfit that has such huge success in bond investments that it has beat out 99% of its peers.

Based on those numbers, it is not surprising to see that the biggest troubles are emerging first in Germany, which I specifically covered in that Deeper Dive. Other financial writers are picking up on that, too, and one story today joins my own voice and asks,

Will commercial real estate trigger the next financial crisis?

…there are dark clouds looming on the horizon: another wave of regional bank troubles added to the burgeoning crisis in the commercial real estate market.

The regional bank crisis was disguised with liquidity, but reality showed that unrealized losses in the banks’ balance sheets rose to all-time highs in the third quarter of 2023. Regional banks remain in deep trouble. According to Moody’s, major US banks are sitting on $650 billion in unrealized losses.

In other words, banks didn’t find a way to pare back their unrealized losses that put some banks in default early last year due to Fed tightening. The problem of their damage reserves became worse.

Things are even scarier in the land of real estate. Recent reports paint a grim picture of the commercial real estate landscape, with delinquency rates soaring to alarming levels and non-performing loans rising. The commercial real estate market, once an example of economic strength, stability, and prosperity, now stands on the edge of crisis.

Delinquency rates in commercial real estate have reached a 10-year high, with almost $80 billion worth of property in distress….

According to real estate experts John Smith, the link between corporate bankruptcies and commercial real estate distress is deeply intertwined. One of the central findings of Smith’s research is the interconnected nature of corporate financial health and commercial real estate performance. He notes that corporate bankruptcies can trigger a cascade of financial repercussions, affecting property values, rental income, and investor confidence.

It works both ways actually: As office buildings go vacant and also plummet in value, all the business around the central business district that supported those officer workers—restaurants, clothiers and other retailers, etc.—also go out of business. The CBD implodes in a vicious circle:

Corporate bankruptcies also exert downward pressure on commercial property values, as distressed companies liquidate assets and reduce their real estate footprint. This can lead to declining rental income and occupancy rates, further exacerbating financial distress for property owners and investors.

It’s a recipe for central business districts to become ghost towns.

Yet another story today, talks about the massive scale of the problem:

Commercial-Property Loans Coming Due in US Jump to $929 Billion

Nearly 20% of outstanding debt on US commercial and multifamily real estate — $929 billion — will mature this year, requiring refinancing or property sales.

The volume of loans coming due swelled 40% from an earlier estimate by the Mortgage Bankers Association of $659 billion, a surge attributed to loan extensions and other delays rather than new transactions.

It wasn't long ago I was writing about that earlier estimate. Already the problem is 40% worse. The Fed is nearing a crisis point in which keeping rates up for longer means all of those loans will have to be refinanced with new bonds at higher rates; and, as I also laid out in that Deeper Dive, there is very little likelihood that the broken labor market will cut the Fed any slack by bringing its second mandate into play, which runs counter to the first mandate. The first says “fight inflation.” The second says “keep labor strong,” but labor looks deceitfully strong to the Fed, and data I hadn’t seen before on the labor market added weight to my longstanding argument that labor is not strong; it is fundamentally week. It is tight due to a severe lack of workers, not due to strong demand from a strong economy. It’s apparent tightness on the Fed’s gauges, however, keeps the Fed forced to fight inflation as it has no counterforce to consider.

With CRE prices down an average of 21% from their 2022 peak, it becomes hard to refinance loans that never paid down the principle, as is the case with most CRE bonds where investors typically only pay interest. Who wants to refi a loan of any kind when the collateral is worth 20% less than the loan? Trouble is brewing for this year. So, yet another story claims,