💼 Fed Didn’t Throw In The Powell

briefcase | invest smarter | Issue #119

PSA before we kick off this week’s newsletter

We finally got Peter the Intern to do something productive with his time! He prepped a guide on the tactics successful real estate entrepreneurs use to find their next deals (and rated them). Just scroll to the bottom of the email, refer someone to Briefcase, and we’ll send you a copy.

😟 Commercial Inertia

Commercial real estate (CRE) owners are in trouble, despite 23% of you polling that things were “great”. That said, 47% said “so so”, which is a better answer, but let’s get into the details.

Following the collapse of several major banks in the U.S., everyone believed the Fed would throw in the Powell on interest rate hikes. But that didn’t happen.

Many believe it’s time to step back and see what the lagging effect the turbo lever of rate hikes will have on our economy.

Nowhere is the effect of higher rates more evident than in the commercial sector, which has longer-term leases, meaning the reckoning is still ahead of us.

If banks were the first shoe to drop in a forthcoming recession, then CRE may be the next. And it all comes down to 💳 credit.

Commercial DIScredit

TLDR: The CRE sector is worth a cool 5.6 trilly, and about $448 billy of that is coming up for renewal in 2023. This is a record number, according to Trepp, CRE debt is currently at record highs.

In the next 3 years, there is $1.5 trillion in CRE debt maturing, the bulk of which was financed when interest rates were zero.

And that debt train hasn’t been slowing down. According to the Mortgage Bankers Association (MBA):

Why is this bad? Many CRE owners have floating-rate mortgages, which means their debt service has already increased dramatically, reducing incomes and, ultimately, valuations. Further, those who have fixed rates will face a similar shock, but not until they have to renew their mortgages. Remember, $1.5 trillion in debt over the next 3 years is coming to maturity.

And renew they shall! But, given the rapid rise in interest rates and the ongoing banking crisis, lenders have been dramatically tightening lending standards meaning that loan-to-values are decreasing.

Lending tightens + dropping valuations + higher debt costs = 😨😨

So what does the Fed say?…🤷‍♂️🤷‍♀️ Powell and the Fed aren’t concerned:

Right…Just like when you said inflation was transitory.

I guess there’s a disconnect in the level of concern over CRE. Scott Rechler, a New York Fed board member, recently chimed in, tweeting:

Well said Scottie Biscotti! Can we call you that?

What's exacerbating this headwind is that a big chunk of CRE—office space—has seen vacancy rates skyrocket. According to reports, office occupancy rates remain around 50% as remote work persists.

Across major markets, the office vacancy trend does not look good.

What about the banks that hold the CRE loans? Considering that at the median U.S. bank, CRE loans account for 38% of their holdings, this wave of debt renewals could get a little default.

For smaller banks, their exposure to commercial debt is even higher, at 43%. Already, we are seeing some high-profile defaults, according to Dani Romero:

Bank Tank

According to a recent academic study from PhDs at Columbia and Stanford University:

We would encourage you all to reread that paragraph if your jaw isn’t currently touching your lower neck. As most banks become more insular and batten down the hatches, they are less and less likely to even make CRE loans, let alone refinance them.

Like we said, things could get a little defaulty.

Ultimately, a crash in CRE would be bad not only for the sector but financial institutions and municipalities that rely on property taxes.

So What? CRE asset classes that continue to have strong demand may weather this debt storm better than others. For instance, vacancy rates remain depressed, and rents are high for the multifamily asset class.

Further, industrial and warehousing are still outperforming. That said, for other CRE assets like retail and office, things could get painful. Like stepping on Lego painful.

Real Estate News

🌎 At Least We Still Have Avocado Toast: Americans are pulling back from the values that once defined the US, with patriotism and religion dropping, while finances saw a jump — WSJ

📉 Extra Guac Please: Rent growth in the US drops to pre-COVID levels — CNBC

💰 Actually, Hold The Guac: The true cost of homeownership in 2023, the average U.S. homeowner spends $17,459 annually on hidden costs — Real Estate Witch 

🏠 Cooling Prices: Home prices cool in January, even falling in some cities — Case Shiller

🏢 Less Cowboys: Europe's banks are in a better place than the US regarding commercial property risk — JP Morgan

🖥️ Listings: Zillow now accounts for nearly half of all real estate web traffic — Inman

📉 WeLost: WeWork halves annual loss to $2.3 billion — TRD