Downward angle icon Downward angle icon. Shutterstock/Getty Images The problems in the U.S. commercial real estate sector seem to be getting worse and spreading. Rising interest rates, tightening bank lending, and falling property values are hitting the sector hard. Some bold buyers are trying to take advantage of the turmoil by snapping up bargains.
The tremors rocking the U.S. commercial real estate industry are spreading to other countries and sectors, threatening to escalate into a financial crisis as refinancing deadlines loom.
But some investors aren't worried about being left behind – they believe the atmosphere of fear and confusion will allow them to pick up prime property at bargain prices.
what happened?
There are growing signs that commercial real estate is in serious trouble.
Barry Sternlicht, the billionaire real estate investor and CEO of Starwood Capital, recently predicted a loss of $1 trillion in office properties alone.
Bloomberg reported this week that more than $900 billion in U.S. commercial and multifamily debt, or more than 20% of all U.S. commercial and multifamily debt, is coming due this year, leaving borrowers with no choice but to refinance at much higher interest rates or sell their properties at steep discounts.
The real estate unease is also being felt in Europe, where the value of German Pfandbriefbank's bonds plummeted this month as investors worried about exposure to the struggling real estate sector.
Moreover, the European Central Bank has warned that it will impose tougher capital requirements on lenders if they do not take commercial real estate risks seriously, sources told Bloomberg.
Meanwhile, some Chinese investors are selling off overseas properties at discounts of 45% or more in an attempt to raise cash to weather a worsening property crisis at home.
A combination of expected losses, refinancing woes, international contagion and panic selling has created a bleak outlook for the commercial real estate sector.
Why is everyone so worried?
Concerns were rekindled this month when New York Community Bancorp abruptly cut its dividend, set aside about $500 million to cover bad loans and reported an unexpected quarterly loss that it blamed on just two bad loans.
Investor pressure sent the bank's shares plummeting 60 percent in five days and they are still trading at their lowest in two decades. The bank's scramble to restructure its finances has revived bad memories of the regional bank fiasco last spring, when Silicon Valley Bank and two others were hit by a wave of withdrawals, seized by the federal government and then collapsed outright.
The catalyst for the banking and commercial real estate drama is a seemingly unimpressive rise in interest rates.
But the simple act of making borrowing more expensive can stifle spending, hiring and investment, pushing up yields on bonds and savings accounts and lowering the prices of risky assets like stocks, putting pressure on debt-dependent industries and slowing the economy into recession.
In response to surging inflation, the Federal Reserve raised interest rates from effectively zero in early 2022 to more than 5% by next summer. They haven't been lowered since then, and other central banks are following suit.
Rising borrowing costs combined with the shift to remote work has reduced demand for offices and other commercial real estate, sending asset values plummeting.
Some regional lenders, including Silicon Valley Bank, did not adequately hedge against rising interest rates last year, causing the value of their bond and mortgage portfolios to fall.
Financial institutions, hit by losses on their books and fearing a surge in payment delays and loan defaults, as well as further bank runs, are pulling back on lending to commercial real estate.
As a result, the financial industry has not only faced a huge increase in interest payments on its huge debt load, but also a credit crunch and declining asset values. Small and medium-sized businesses are also feeling the squeeze from rising borrowing costs and stricter lending standards.
On the bright side, inflation has fallen to below 4% in recent months from a 40-year high of 9.1% in the summer of 2022, and the Fed is set to cut interest rates several times this year.
But with many real estate loans coming due in the next year or two, questions are being raised about whether interest rates will fall fast enough to prevent a catastrophic event.
In fact, data firm Trepp estimates that roughly $2.2 trillion in commercial mortgages are set to mature by the end of 2027.
“At some point, that avalanche is going to hit you,” the company's chief product officer told The Wall Street Journal.
Hold on, are there buyers entering this market?
Yes, Warren Buffett famously preaches, “Be greedy when others are fearful,” and some brave people take that advice to heart.
Ian Jacobs, a former assistant to the CEO of Berkshire Hathaway, is planning to buy 3 million square feet of office space in San Francisco for about 70% less than it would cost to build it, The Wall Street Journal reported this week.
The report said he has already raised $750 million from investors, despite warning that it could take 10 years for prices to recover.
Jacobs is a member of the Reichman family, which means bargain hunting is pretty much a family business, as his relatives built a real estate empire by buying up cheap properties as New York City neared bankruptcy in the 1970s.
Manhattan in the 1970s. HUM/Getty Images
Other examples include Ares Management and RXR, two investment firms that are buying interests in 3 million square feet of office space, sources told The Wall Street Journal.
In December, the Aon Center in downtown Los Angeles sold for about $148 million, Bloomberg reported, significantly lower than the $268 million it sold for in 2014.
Additionally, “Undercover Billionaire” star and real estate mogul Grant Cardon hailed the ongoing correction as a rare opportunity for ordinary people to buy “trophy real estate” from institutional investors.
Of course, commercial real estate players have a vested interest in touting the industry's woes as a buying opportunity, given that it could revive investor interest and reverse a steep decline in property values.
But some prime assets are likely to get caught up in the selling, and those who buy them at a time when uncertainty is widespread and debt-laden developers are in a race against the clock may ultimately be rewarded for their courage.