The posted article doesn't have any relevant content ("Try unlimited access Only $1 for 4 weeks"), but based on the headline all I can think is please please pretty please maybe this time the government can perhaps let some defaulting actually happen? Of course we know the answer is always going to be more money printing to support the rigged heads-they-win tails-we-lose game, and the whole point of this article is part of the media push to make that happen. The main question is what related sector of the economy they'll ruin in the process.
I actually didn't even try that, because archive.is is so often broken. But surprisingly there were only two captcha-nags (not the usual infinite loop!) and it actually worked.
Do you realize the impact this would have on pension plans and mom and pop investment portfolios too? It isn’t just Bezos and other billionaires who would feel pain - it would be a lot of regular folk getting annihilated financially as well.
Doubt it. Most people are well diversified. I'd be surprised if anyone's retirement was more than 20% commercial real estate. Easy to stomach some moderate losses in the sector even at that absurdly high allocation.
Have you done the math, even at a ballpark level? Commercial Real Estate (CRE) is estimated to have ~$500B loss in 2023 and nearly the same in 2024 (different from debt repayment) [1]. Stock indices were fine. In general, there's way more private investment/ownership in CRE. The market can suffer a lot more in losses before it starts to meaningfully affect mom&pop. Even stocks like SLG and BX have done fine last year.
Sure. "Investment" used to mean that what you invested was at risk, and if you (or whomever you delegated to) made bad investments you would lose. The answer to the current hazardous dynamic where everyone just dumps money into investment funds on autopilot is not to double down and bail them out so the Potemkin party can continue. Rather the negative possibilities of such investments need to be demonstrated so that people are appropriately leery of relying on them going forward.
A lot of those regular folks could have kept their money in US Government bond funds or in FDIC backed bank accounts as well. They invested in commercial real-estate paper because they wanted higher returns than those bonds funds would provide. Usually higher returns means accepting higher risk.
Maybe to level the playing field the government should publish a list of investments with high returns and implicit government guarantees so that we’d all know where to put or retirement money. It really screws with my retirement planning to only find out after the fact.
There are consequences for both courses of action, if you bail out the banks
-you are diluting the wealth of primarily poor people who save instead of invest
-real estate prices will scream upwards having barely paused for the fed rate hikes
-you will distribute more of societies scarce resources into already failed investments, less of what people want and more of what people demonstrably dont.
Only one of these two options is actually moral; in the case of no bailout, investors who have provably acknowledged the risk of investing, and who still recklessly barrelled cash into an industry that everyone knows is a bubble, take a haircut based on the risk they themselves chose.
In the bailout reality (aka reality because we all know how this ends), you commit mass theft to bail out a failed investment. We can cut onions over how broken the stock market is for the average person, as I do on a daily basis, but that isnt justification to absolve people of the basic and predictable economic consequences of their choices, and certainly not to place those consequences on someone elses back.
You won't have fixed anything, investors wont get spooked, prices wont finally come down, they will see the blood in the water and continue doubling down on risky investments. They now know the government would sooner shake you down then let their investment fail, its all upside for them and all downsides fall to you, humble tax payer.
I understand the sentiment, and often feel this way too, but I think it's reductive to assume the answer is to let large companies/investors to fail.
Ideally, if we ensure adequate diversity in the market, then having companies default makes sense -- then one company going under won't trigger a string of defaults that can cripple a sector of the economy.
But when we let businesses concentrate effort or corner markets, then there can be catastrophic consequences to the economy when these large entities go belly up. Efforts should be put in place to mitigate these issues.
Ultimately, I think the pragmatic approach is to assess defaulting on debt on a case-by-case basis. I'd prefer if a panel of economists across the ideological spectrum came to a consensus for each case based on the latest understanding of the market, but I know it's more likely going to be politicians choosing the argument that best fits their worldview.
I do agree that limiting scopes ahead of time would be a better overall solution. The problem is that for the next part of the cycle, when the idea of regulation to limit the financialization is being debated, it will be rejected because the immediate crisis is over. So I'd say it's appropriate to argue against the scheme at each turn, even though only one aspect needs to be reformed to have just system.
Also, aiming for better outcomes would be more important for situations affecting resources in the real world. But commercial real estate has to be one of the most abstract setups there is. The buildings will still exist. The tenants will still exist, still carrying out their business, making rent payments, and for the most part keeping up the properties. The only thing that changes is the paper ownership moves to the senior debt holder, and the more leveraged investors get wiped out.
This condition was created by the government selecting winners and losers in the first place. The market has to decide who wins and who loses to achieve any normal distribution of resources, otherwise it will always be captured by politicians and/or corporations.
There can be no agreement among "economist across the ideological spectrum", there can only be agreement among economists who agree with bailouts, or agreement among economists who disagree with bailouts. We have directly opposing views on what makes something moral, on how value is created, even on what money is; there cant be any agreement when the differences in fundamental assumptions directly conflict. Naturally those against bailouts will be marginalized and called fringe kooks that can be safely ignored.
2024 will make for an interesting year for the debt world. Seems like everyone and everything has debts coming due. Commercial real estate no exception.
commercial real estate tumbles. Followed by municipal bonds tumbling. Cities file for bankruptcy. Growth stagnates permanently since the income from taxes does not fully sustain most cities today. This is largely due to highly inefficient city planning and infrastructure planning (suburban sprawl, highways, and continued dependency on car centric travel generate significant amounts of long term debt that accrue at all levels).
Growth can now decouple from cities however. Whether they are run well or not is largely immaterial to the legions of remote workers who can simply leave or even emigrate but remain economically active at the same level or even higher.
This is the rumor at my work about management’s push for RTO. Some amount of tax incentives were provided because the office would drive additional downtown spending. Spending and tax income which does not materialize if the peons can stay at home.
A few phone calls from the mayor , and “our company culture works best in person”.
> This is the rumor at my work about management’s push for RTO. Some amount of tax incentives were provided because the office would drive additional downtown spending.
I guess I can sort of see that if the company is locked into a lease. But I can't see that playing out in the long term - It's hard for me to believe that the city is ponying up more than the cost of corporate rent in tax incentives.
RTO is “free” and does not hit the financials in the same way as having to record the loss of a $X tax break.
Additionally, I recall some of the sweetheart deals which were being offered for the new Amazon headquarters. I could believe that officials offer ludicrously good deals that never pencil out for the city. Like sports stadiums.
It doesn't sound like much, I mean what does a billion buy you these days? A couple of villas and a yacht and you're done.
Also, according to TFA, this is about 600 buildings, of which 224 might be problematic. What happens when they are not refinanced? They are owned by the bank just the same.
This can be a "tip of the iceberg" type figure. If interest rates remain high or go higher and economy continues to slide or if the need for office space due to remote work is permanently reduced, then demand will continue to fall and then $117B can snowball into trillions rather quickly.
This is actually a very big topic in economics right now. By our usual metrics (not just gdp but many others) the economy is great. The top theories on why this hasn’t translated to how people feel are a) the metrics we collect aren’t that relevant to the lived experience (but if so why have they traditionally correlated to people’s feelings) b) the metrics have measurement error (but if so why can’t we find it?) or c) people’s feelings are more influenced by other things than the economy (such as their media consumption, societal changes, etc) and that carries over into the “vibes” measurement.
But, by the measures we have about the broad economy things are pretty good.
Serious question, in what circles are those top theories? I am sure C plays into it, and I know I live in a bubble; but I would expect any list of this type to include something like: large scale upward wealth transfers from bailouts/stimulus in 2008/2009 and covid, which has resulted in zombie companies taking over major sectors of the economy; or, trade deficits caused by our money being the global reserve asset have hollowed out the industrial base, obviously economically but also spiritually as people have lost the jobs that made them feel like they contribute to society. Im not trying to get at you or something, I just genuinely want to know where people are talking like this, what do they think about, how do they see things, thats all.
But as a for instance on one of the things you mentioned, our trade imbalance is less now than it was in the early 2000s. US industrial jobs have been on a negative trend for more than 50 years! That doesn’t correlate with the split between sentiment and other metrics either.
Thanks for the link; I find myself more sympathetic to the corollary of your second metric, that we are at a 50 year low in industrial work, to be a viable explanation; though ill admit my surpise that trade defecits are lower than the early 2000s, that ill need to dig into more.
There are more workers employed in manufacturing in real terms now than 20 years ago as well. In a % of population basis that’s not true so maybe there is some effect on sentiment based on the % of people employed in that sector?
I’ve not seen that put forth as a hypothesis anywhere but I’m certainly not an expert.
Which gains? Wage gains are up for the first time since the 70s and it’s concentrated at the bottom of the wage curve.
There is increasing wealth disparity which maybe contributes? I’m not a an expert on economic sentiment but it seems surprising that the wealthy getting a little more wealthy as a % of the economy would have broad sentiment effects, but perhaps.
What is Gen Z, along with the other terminally-online older people going to do with themselves if there actually is ever another recession? Gen Z'ers entire teenage and adult lives have been in a period of huge economic growth which continues today. They have no concept of how bad a recession actually feels. I suspect that this is a contributing factor to the vibecession: younger adults don't know what recessions feel like.
If this is the level of complaining happening during an economic expansion, what are they going to do in a contraction? When wages drop precipitously? When they send out hundreds of resumes and hear back on none of them? When having unemployed friends becomes ubiquitous?
Or maybe the vibecession isn't real at all and virtually everyone saying we're in a recession doesn't actually believe it and is just virtue signaling support for poorer people?
That’s nominal GDP, real GDP only increased about 2%. Inflation is starting to get under control but the ~3% average this year is still over the Fed’s target. We’re no longer in dire straits but “As good as it has ever been” is definitely a stretch. The dangerous part will be the effects of coming back from a zero interest regime. Foreclosure rates for example started rising last year for the first time since the GFC and in 2023 they increased roughly 18% YoY
The thing is - I'm not sure the bank wants to own any of those buildings, even profitable ones. It's a bank, not a real estate investment fund. The amount of money spent on upkeep, taxes, land, finding a buyer, etc... can be and often is quite significant and for a bank, that's capital that could be better deployed elsewhere (which also more often than not aligns better with the core functionalities of the bank).
Obviously bank managers and loan officers prefer that borrowers pay as agreed. But lenders know that they will have to repossess a certain percentage of properties, and they have employees or contractors available to manage those until a sale. It's all expected and built in to the commercial lending business model.
Agree. I could see this being a “do your business or get off the toilet” moment. One option is repurposing that real estate to better purposes, like residential or industrial depending on location. It would take significant amounts of investment, but that’s actually the market working as intended.
I am aware of attempts to repurpose such properties, cheaply, to residential have generally sucked. That just indicates better, costlier options will need to be explored. High rises and high density living actually exist many places.
Does not yet sound like a hair on fire/bailouts level problem. We would need to see some Ts instead of Bs for that.
Then there’s the reality of the US economy still responding to the changes following the pandemic. Literally all modern markets have not experienced anything like this since the last pandemic was 1918. That was a very different time in international and national trade.
The market is a hugely decentralized grouping of economies. Each economy itself composed of millions to billions of individuals making individual decisions with finite resources. That’s precisely the genius of the system. No single person or policy maker could take on and make all the most optimized decisions for all the people in the global market.
Lowering the value of commercial real estate would also be helpful. I know of two stores that had to shut because the landlord raised the rent significantly. The landlord did that because the value of the real estate is proportional to the rent rates. The stores stood empty for a considerable time. Nobody won.
The bank judges loan viability based on the rental income of the property. Lowering rent in that case might cause the loan to become underwater (acknowledging lower income), and they are better off not renting at all than lowering the rent (not acknowledging lower income even if that means no income).
> What happens when they are not refinanced? They are owned by the bank just the same.
A fiend in CRE explained that defaulting on these debts is a calculated risk built in to the office owners' business models.
They secure financing with the hope that the investment will pay off, but if it goes under then they let that specific building's isolated business fail. The bank takes ownership of the property and must sell it off at a discount.
The same people who owned the building originally might then go back and bid on the same building again at the new, lower rate.
Both the banks and the CRE operators understand that his is how the game is played, so it's priced in to the cost of financing (in theory). Letting the bank repossess a property is just a business decision.
Unlike US home loans, commercial mortgages are almost entirely interest- only. That means developers of large properties tend to have low monthly payments, but face a balloon payment equal to the original loan the day the mortgage comes due.
That is an odd detail I was not aware of... this seems to be a significant advantage for commercial mortgages over residential ones. Are they less leveraged or something? That doesn't square with the "40 per cent of office loans on bank balance sheets were under water" statement later in the article.
This is not driven by fundamentals; this has everything to do with financing costs going back up
Seems like a disingenuous statement. Demand for office space has fallen. And according to the article, demand was overstated when these now-due loans were originally made.
“Everyone will blame Covid [for] the losses,” said John Griffin, a professor at Texas university. “But Wall Street’s aggressive underwriting of commercial mortgage debt is going to make the situation a whole lot worse than it would have been.”
> this seems to be a significant advantage for commercial mortgages over residential ones.
"Interest only" loans are not really advantageous. It means by default you are never paying down your principal and you are forced to refinance when the balloon payment is due (usually 5 years or so). So if you signed a loan when rates were low, you would have been better off to get a long term 30 year fixed interest loan. Otherwise your payment can more than double or triple right along with interest rates.
And since you're not paying down the principal, it's easier to find your loan under water. Although it is typical for commercial real estate loans to require a 20% down payment.
You can - at least some places - get residential mortgages that are interest only too, but they're not popular for good reason because of the risk involved.
I think this just reflects a sales strategy. Back when it didn't look like commercial was risky, you could win business by advertising a low monthly payment.
Interest-only works for commercial because the building is (hopefully) making money, so some of that can be set aside to handle the last payment. That doesn't work for residential, because single-family homes don't usually make money, so residential homebuyers don't typically have ~$200,000-$2,000,000 in cash at the end of the 30 year period. But if that was feasible, you would see some loan officers trying to win business through offering interest-only mortgages with a balloon payment.
As for why underwriting didn't catch this? Underwriting is a lot like actuaries, they've got a bias towards recent population-level data. So for the last 30 years the rates of commercial default have been predictable, and it's tough to push back to execs on the risk. You're claiming that a potential wide-scale change in the way the U.S. works should impact sales strategy today, and before Covid that risk was very abstract. Very few execs would side with their underwriters over their sales team, and there's been subtle pressure on underwriters to price commercial real estate as though systemic risk isn't real.
The building operation pays the interest (and upkeep). The last payment is the whole loan - it comes from a refinancing: rolling over the whole thing from one loan to the next one - or from a sale (same thing actually: rolling over from one property to another). The issue is that since the last refinancing, interest rates changed.
It usually comes from a refinancing, but doesn’t have to! Any land productive enough to recoup its development costs before the balloon payment is due is a good fit for these loans. Refinancing was so common because interest rates historically went down, but hopefully some of the underwriting data prior to this last low interest rate environment would contain some bad loans caused by the lendee not saving enough for the balloon payment. That is hopefully a part of the underwriting model, unless they have a truly short lookback period.
I don't know where you are. Let us know how it works there. (1) In the US, most commercial real estate loans are short term. Three years or something? (looks like 3-10, longer than I thought) (Perhaps construction loans are longer). Far too short for the owner to repay the loan even if they wanted to. (2) And there is little reason for the real estate investor to repay the principal (except through sale or refinancing) - that would be leaving money on the table. You don't need to repay the principal. As long as you are in good standing you can roll over the loan into the next one - refinance. You can stay leveraged and use any profits to live on and buy more property (Until - not infrequently - things go bust and the bank owns the building.)
A different case might be a condo development: Private investment (rolled over from selling another property and repaying THAT loan) and loans to buy the land, loans to build, sell 60% of the units, - and there might be enough to repay most of the loan.
I don’t think this is the typical borrower profile now, but balloon loans are historically for people who have most of the cash needed for development (or who have all the cash needed and think that they can get a 10% return while their interest rate is 6% over the life of the loan.)
In that case, since you already have most of the capital lying around, a balloon payment lets you use other cash but you’re not worried about a large payment.
Seems like a lot of commercial real estate is structured as a balloon loan to people who may not be able to make the lump sum payment, which is probably where the underwriting failure lies. Refinancing is a tool a savvy borrower can use as rates go down, but it’s not a strict expectation that you do that if you get a balloon loan, even on short term loans.
>> That doesn't work for residential, because single-family homes don't usually make money, so residential homebuyers don't typically have ~$200,000-$2,000,000 in cash at the end of the 30 year period
Before the US government got involved, the typical real estate loan was a 5 or 10 year balloon loan that had to be refinanced at the end of the loan period. Large part of them were interest only. So that's exactly the way it used to work.
That blew up during the Great Depression. Then the government stepped in and started subsidizing loans which is where we're at now, the mortgage market in the US is very different than in say Canada or Europe.
This kind of mortgage was very popular before 2008. Many US homes were mortgaged at interest only rates. People however saw how dangerous this can be in the aftermath of the great recession, as a record number of Americans lost their homes.
You can get residential interest only mortgages - at least here in the UK.
I used to have one, but remortgaged to repayment ten years ago.
It's quite common to see "buy to let" mortgages as interest only rather than repayment, where the owner is concerned with cashflow rather than the asset itself.
It'd be interesting to see the total value of derivatives based on these mortgages is, I didn't see that in the article anywhere.
Anyone happen to know how common it is for these kinds of commercial real estate loans to be rolled up into other derivatives similar to what led to the housing crisis?
Maybe I'm reading right past it somehow? I reread the article and was only seeing numbers related to outstanding debts, I didn't see mention of the derivative value secured with these loans.
If you are wondering why you are returning to office (RTO) despite 3-4 years of profitable quarters… It’s not because of “cUlTuRe”, “wOrK pRoDuCtIvItY”, “coMmUnIcaTiOn gApS”, or “iNcReAsInG cOlLabOraTiOn”
It’s because the bag holders of these assets (ie, REITs, ibanks, hedge funds, foreign ibanks and investors) are at risk. Ultimately, the US government and to a certain degree state and local governments have guaranteed a large portion of these assets.
These investors need to pump their numbers (ie, occupancy rates, leases, …) in order to keep the con going. Often the building managers will dangle “free” upgrades in the faces of these corporate real estate managers to keep the leases active in exchange for guaranteed occupancy rates.
I hate this country sometimes. Shit like this is why we will never have a sustainable economy
Why would a company RTO to keep the building's investors happy? They probably have different owners whose interests are at odds.
The real estate guys want the building full to maximize rent income, but the company owners want to minimize rent expense. They are min-maxing against one another.
Companies RTO because:
a) they are run by people who don't get remote work
b) they do something that involves being physically present
c) layoff-by-RTO
d) it's possible the government incentivizes RTO, but this is a short-term trick at best. RTO is unpopular with workers and most capital are invested in companies, not office buildings. All of those companies have a natural interest in minimizing rent.
Expect a ton of restructuring deals. Banks don’t want to repossess these properties, especially in the middle of this economy. At this level banks are partners, not just lenders. They have a vested interest in keeping these buildings useful. A multimillion dollar building is not a user car or even a suburban home.
But commercial mortgages usually have stipulations like a minimum rental price. Everyone boogie man’s zoning, but these mortgages also limit freedom. Many empty buildings couldn’t rent at a lower price even if they wanted to. The banks don’t want managers undercutting each other, and wrecking market value. But they will have to relent eventually.
Expect less new builds in the future, but more renovations. Building managers face a tough market right now, and will need to invest in existing stock to compete.
I recently discovered that in my old neighborhood in Chicago, 4 high rise residential towers have started construction in a 3-block radius in the last 6 months. And over on the other side of downtown, developers have secured financing to begin construction of an 800+ foot tall apartment building on the site of the $300 million hole in the ground (an Irish developer had planned to built a 2000 foot tall building, but went bankrupt while building the foundation).
I saw a report by the city of Chicago last month that broke out office vacancy by age of the building, and in new towers the vacancy rate is single digits. Now, you and I both know that the likely explanation is that the tenants of these buildings were solid companies that signed long-term leases as the construction was finishing up. Once those first leases end, all bets are off.
But, “It Is Difficult to Get a Man to Understand Something When His Salary Depends Upon His Not Understanding It”. Builders are going to point at that stat and say that new office towers are a good investment. Lenders are going to point at that stat and say that new office towers are safe to finance.
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[ 3.1 ms ] story [ 154 ms ] threadIt's good that you're open about only having read the headline. Another user posted a link to the full article text: https://archive.is/VYBn9
Do you realize the impact this would have on pension plans and mom and pop investment portfolios too? It isn’t just Bezos and other billionaires who would feel pain - it would be a lot of regular folk getting annihilated financially as well.
[1] https://finance.yahoo.com/news/commercial-real-estate-values...
If the 0.1% owns a disproportional amount of wealth any financial bailout will disproportionately help them.
https://www.calpers.ca.gov/page/investments/about-investment...
Maybe to level the playing field the government should publish a list of investments with high returns and implicit government guarantees so that we’d all know where to put or retirement money. It really screws with my retirement planning to only find out after the fact.
Only one of these two options is actually moral; in the case of no bailout, investors who have provably acknowledged the risk of investing, and who still recklessly barrelled cash into an industry that everyone knows is a bubble, take a haircut based on the risk they themselves chose.
In the bailout reality (aka reality because we all know how this ends), you commit mass theft to bail out a failed investment. We can cut onions over how broken the stock market is for the average person, as I do on a daily basis, but that isnt justification to absolve people of the basic and predictable economic consequences of their choices, and certainly not to place those consequences on someone elses back.
You won't have fixed anything, investors wont get spooked, prices wont finally come down, they will see the blood in the water and continue doubling down on risky investments. They now know the government would sooner shake you down then let their investment fail, its all upside for them and all downsides fall to you, humble tax payer.
Ideally, if we ensure adequate diversity in the market, then having companies default makes sense -- then one company going under won't trigger a string of defaults that can cripple a sector of the economy.
But when we let businesses concentrate effort or corner markets, then there can be catastrophic consequences to the economy when these large entities go belly up. Efforts should be put in place to mitigate these issues.
Ultimately, I think the pragmatic approach is to assess defaulting on debt on a case-by-case basis. I'd prefer if a panel of economists across the ideological spectrum came to a consensus for each case based on the latest understanding of the market, but I know it's more likely going to be politicians choosing the argument that best fits their worldview.
Also, aiming for better outcomes would be more important for situations affecting resources in the real world. But commercial real estate has to be one of the most abstract setups there is. The buildings will still exist. The tenants will still exist, still carrying out their business, making rent payments, and for the most part keeping up the properties. The only thing that changes is the paper ownership moves to the senior debt holder, and the more leveraged investors get wiped out.
There can be no agreement among "economist across the ideological spectrum", there can only be agreement among economists who agree with bailouts, or agreement among economists who disagree with bailouts. We have directly opposing views on what makes something moral, on how value is created, even on what money is; there cant be any agreement when the differences in fundamental assumptions directly conflict. Naturally those against bailouts will be marginalized and called fringe kooks that can be safely ignored.
Not an expert so I can only really pose the question.
I guess I can sort of see that if the company is locked into a lease. But I can't see that playing out in the long term - It's hard for me to believe that the city is ponying up more than the cost of corporate rent in tax incentives.
Additionally, I recall some of the sweetheart deals which were being offered for the new Amazon headquarters. I could believe that officials offer ludicrously good deals that never pencil out for the city. Like sports stadiums.
To wit, most employers aren't paying for each hour of employee time wasted by commuting, nor fuel/ maintenance costs for vehicles.
It might lead to higher employee turnover and difficulty hiring, but that is delayed and indirect.
Also, according to TFA, this is about 600 buildings, of which 224 might be problematic. What happens when they are not refinanced? They are owned by the bank just the same.
But, by the measures we have about the broad economy things are pretty good.
But as a for instance on one of the things you mentioned, our trade imbalance is less now than it was in the early 2000s. US industrial jobs have been on a negative trend for more than 50 years! That doesn’t correlate with the split between sentiment and other metrics either.
I’ve not seen that put forth as a hypothesis anywhere but I’m certainly not an expert.
Thoughts?
There is increasing wealth disparity which maybe contributes? I’m not a an expert on economic sentiment but it seems surprising that the wealthy getting a little more wealthy as a % of the economy would have broad sentiment effects, but perhaps.
If this is the level of complaining happening during an economic expansion, what are they going to do in a contraction? When wages drop precipitously? When they send out hundreds of resumes and hear back on none of them? When having unemployed friends becomes ubiquitous?
Or maybe the vibecession isn't real at all and virtually everyone saying we're in a recession doesn't actually believe it and is just virtue signaling support for poorer people?
I am aware of attempts to repurpose such properties, cheaply, to residential have generally sucked. That just indicates better, costlier options will need to be explored. High rises and high density living actually exist many places.
Does not yet sound like a hair on fire/bailouts level problem. We would need to see some Ts instead of Bs for that.
Then there’s the reality of the US economy still responding to the changes following the pandemic. Literally all modern markets have not experienced anything like this since the last pandemic was 1918. That was a very different time in international and national trade.
The market is a hugely decentralized grouping of economies. Each economy itself composed of millions to billions of individuals making individual decisions with finite resources. That’s precisely the genius of the system. No single person or policy maker could take on and make all the most optimized decisions for all the people in the global market.
A fiend in CRE explained that defaulting on these debts is a calculated risk built in to the office owners' business models.
They secure financing with the hope that the investment will pay off, but if it goes under then they let that specific building's isolated business fail. The bank takes ownership of the property and must sell it off at a discount.
The same people who owned the building originally might then go back and bid on the same building again at the new, lower rate.
Both the banks and the CRE operators understand that his is how the game is played, so it's priced in to the cost of financing (in theory). Letting the bank repossess a property is just a business decision.
That is an odd detail I was not aware of... this seems to be a significant advantage for commercial mortgages over residential ones. Are they less leveraged or something? That doesn't square with the "40 per cent of office loans on bank balance sheets were under water" statement later in the article.
This is not driven by fundamentals; this has everything to do with financing costs going back up
Seems like a disingenuous statement. Demand for office space has fallen. And according to the article, demand was overstated when these now-due loans were originally made.
“Everyone will blame Covid [for] the losses,” said John Griffin, a professor at Texas university. “But Wall Street’s aggressive underwriting of commercial mortgage debt is going to make the situation a whole lot worse than it would have been.”
"Interest only" loans are not really advantageous. It means by default you are never paying down your principal and you are forced to refinance when the balloon payment is due (usually 5 years or so). So if you signed a loan when rates were low, you would have been better off to get a long term 30 year fixed interest loan. Otherwise your payment can more than double or triple right along with interest rates.
And since you're not paying down the principal, it's easier to find your loan under water. Although it is typical for commercial real estate loans to require a 20% down payment.
Interest-only works for commercial because the building is (hopefully) making money, so some of that can be set aside to handle the last payment. That doesn't work for residential, because single-family homes don't usually make money, so residential homebuyers don't typically have ~$200,000-$2,000,000 in cash at the end of the 30 year period. But if that was feasible, you would see some loan officers trying to win business through offering interest-only mortgages with a balloon payment.
As for why underwriting didn't catch this? Underwriting is a lot like actuaries, they've got a bias towards recent population-level data. So for the last 30 years the rates of commercial default have been predictable, and it's tough to push back to execs on the risk. You're claiming that a potential wide-scale change in the way the U.S. works should impact sales strategy today, and before Covid that risk was very abstract. Very few execs would side with their underwriters over their sales team, and there's been subtle pressure on underwriters to price commercial real estate as though systemic risk isn't real.
A different case might be a condo development: Private investment (rolled over from selling another property and repaying THAT loan) and loans to buy the land, loans to build, sell 60% of the units, - and there might be enough to repay most of the loan.
In that case, since you already have most of the capital lying around, a balloon payment lets you use other cash but you’re not worried about a large payment.
Seems like a lot of commercial real estate is structured as a balloon loan to people who may not be able to make the lump sum payment, which is probably where the underwriting failure lies. Refinancing is a tool a savvy borrower can use as rates go down, but it’s not a strict expectation that you do that if you get a balloon loan, even on short term loans.
Before the US government got involved, the typical real estate loan was a 5 or 10 year balloon loan that had to be refinanced at the end of the loan period. Large part of them were interest only. So that's exactly the way it used to work.
That blew up during the Great Depression. Then the government stepped in and started subsidizing loans which is where we're at now, the mortgage market in the US is very different than in say Canada or Europe.
I used to have one, but remortgaged to repayment ten years ago.
It's quite common to see "buy to let" mortgages as interest only rather than repayment, where the owner is concerned with cashflow rather than the asset itself.
Anyone happen to know how common it is for these kinds of commercial real estate loans to be rolled up into other derivatives similar to what led to the housing crisis?
It’s because the bag holders of these assets (ie, REITs, ibanks, hedge funds, foreign ibanks and investors) are at risk. Ultimately, the US government and to a certain degree state and local governments have guaranteed a large portion of these assets.
These investors need to pump their numbers (ie, occupancy rates, leases, …) in order to keep the con going. Often the building managers will dangle “free” upgrades in the faces of these corporate real estate managers to keep the leases active in exchange for guaranteed occupancy rates.
I hate this country sometimes. Shit like this is why we will never have a sustainable economy
The real estate guys want the building full to maximize rent income, but the company owners want to minimize rent expense. They are min-maxing against one another.
Companies RTO because:
a) they are run by people who don't get remote work
b) they do something that involves being physically present
c) layoff-by-RTO
d) it's possible the government incentivizes RTO, but this is a short-term trick at best. RTO is unpopular with workers and most capital are invested in companies, not office buildings. All of those companies have a natural interest in minimizing rent.
But commercial mortgages usually have stipulations like a minimum rental price. Everyone boogie man’s zoning, but these mortgages also limit freedom. Many empty buildings couldn’t rent at a lower price even if they wanted to. The banks don’t want managers undercutting each other, and wrecking market value. But they will have to relent eventually.
Expect less new builds in the future, but more renovations. Building managers face a tough market right now, and will need to invest in existing stock to compete.
Builders want to build, and lenders want to lend.
I recently discovered that in my old neighborhood in Chicago, 4 high rise residential towers have started construction in a 3-block radius in the last 6 months. And over on the other side of downtown, developers have secured financing to begin construction of an 800+ foot tall apartment building on the site of the $300 million hole in the ground (an Irish developer had planned to built a 2000 foot tall building, but went bankrupt while building the foundation).
I saw a report by the city of Chicago last month that broke out office vacancy by age of the building, and in new towers the vacancy rate is single digits. Now, you and I both know that the likely explanation is that the tenants of these buildings were solid companies that signed long-term leases as the construction was finishing up. Once those first leases end, all bets are off.
But, “It Is Difficult to Get a Man to Understand Something When His Salary Depends Upon His Not Understanding It”. Builders are going to point at that stat and say that new office towers are a good investment. Lenders are going to point at that stat and say that new office towers are safe to finance.
Count on it.