Here’s some alpha for my regular readers, if I have one.
Many of you may have noticed that, over the last three years, office occupancy has fallen off a cliff.
But also note that, recently (within weeks), some of the highest profile, and most solvent landlords – names like Pimco and Blackstone – are actively pushing their underperforming office portfolios into bankruptcy and rushing to give the keys to the creditors without a fight.
So why is this issue only gaining urgency now?
Recall that interest rates were near zero from 2020-2021, but, now about to exceed 5, the carrying cost of huge CRE debt loads, most of which is set to mature in 2023 and 2024, is no longer tenable.
While refinancing at 0% is one thing, doing so at 5% – the highest since 2007 – is another.
Bloomberg agrees there’s a big problem in this sector, and writes that for years, even before COVID, property owners have been grappling with the rise of remote work — a problem so large that roughly 330 million square feet (31 million square meters) of office space will become vacant by the end of the decade as a result, according to Cushman & Wakefield .
But low interest rates allowed the investors to muddle along more easily without worrying about the debt.
Now, many office landlords are seeing borrowing costs skyrocket, leading owners such as Pimco’s Columbia Property Trust and Brookfield Corp. to default on mortgages.
While remote work hurt the office market, rising rates could push landlords to the brink: 48% of debt on office properties that matures this year has a variable rate, according to Newmark Group Inc.
“If you have a loan coming due this year, you’re in trouble,” GFP Real Estate Chairman Jeffrey Gural said.
“If you have a loan coming due in three years and you don’t have a lot of vacancy, you’re going to just wait it out.”
Gural’s GFP recently defaulted on a Manhattan office building on Madison Avenue and is in talks with lenders to extend the loan.
And remember who Goldman’s analysis revealed is financing most of these office spaces — small-to-mid sized banks, which account for “80% of total commercial real estate lending” (along with 50% of US commercial & industrial lending and 60% of residential real estate lending.”
In conclusion, even without the office real estate crisis, small banks were already headed for an unsettling mix of reduced funding and more underperforming loans.
Throw in a cascade of bad debt in exposure to office real estate and you could see a repeat of the 2009 banking crisis for the small banks… if only in the beginning, because once the small banks go down, the big banks won’t be far behind.
The question this time is whether the risk of a cascade of small bank failures will be enough to force the Fed to reverse its tightening path.
But what if it’s the desire of the JP Morgans and Goldman Sachs of the world (and, thus, of the New York Fed) to get to a point where there is a cascading collapse among the smaller banks which will only make the bigger banks even more powerful, at which point, the Fed capitulates and floods the system (a system comprised of fewer banks) with epic liquidity?
That the endgame of the Federal Reserve is the controlled implosion of the banking sector, and subsequent centralization under Wall Street goliaths?
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