a Slow motion crunch It is unfolding in the commercial real estate market, thanks to the double whammy of rising interest rates and falling demand for office space in the wake of the Covid-19 pandemic.
John Fish, president of the Suffolk construction company, president of the Real Estate Roundtable think tank and former chairman of the Boston Federal Reserve, joined the What is happening Podcast to discuss issues facing the sector.
Below are some highlights from the conversation, which have been summarized and edited for clarity. click here To listen to the full podcast.
s. Can you talk to us about why the rate hikes we’ve seen are dangerous for this sector?
A: When you talk about these large structures, especially in New York City, you get all these buildings there, almost a hundred million square feet of vacant office space. It’s amazing. And you say to yourself, well, we’re now in a position where these buildings are about 45%, 55%, 65% occupied, depending on where they are. And all of a sudden, the capital cost of supporting those buildings nearly doubled. So you have a double whammy. You have lowered the occupancy, so the value has decreased, the income has been reduced, and the cost of capital has gone up considerably. So you have a situation where timing really affected the development industry in a big way.
The biggest problem now is because of that, the capital markets froze nationwide. The reason they are frozen is that no one understands the value. We cannot rate price discovery because very few assets were traded during this time period. Nobody understands where the bottom is. So, until we get some sense of price discovery, we’re never going to slog through it.
Now, what I would tell you is that the light at the end of the tunnel came a little while ago, in June when the Federal Coordinating Commission, the FDIC and others filed in the federal government Policy guidance for the industry as a whole. And I think that policy guidance is very, very important for two reasons. First, it shows the government a sense of leadership on this issue because it’s this issue that people don’t want to broach because it can be carcinogenic at the end of the day. It also provides a sense of direction and support to the lending community and to the borrowers as well. And in doing so, what is happening now is clarity.
Basically what they’re saying is similar to previous distressed debt restructuring programmes. They’re saying, listen, any asset out there where you have a qualified borrower and you have quality assets, we’re going to let you work with that borrower to make sure that you can re-create the value that was there in the asset itself. And we’ll give you an extension of 18 to 36 months, basically “pretend and extend.” while What happened in 2009This was more of a long-term guidance proposal and has already affected SIFIs (System-wide Important Financial Institutions). This policy orientation is already directed towards the regional banking system. And why do I say that because SIFIs right now don’t have a real big book of real estate debt, maybe less than 8% or 7%. While regional banks are all over the country right now thousands of them probably own more than 30% to 35% and some have up to 40% of the book in real estate. So this guidance at least gave good assets and good borrowers a chance to have a workout at the end of the day.
Q: Thisstretch and pretendAn idea that sounds to me almost like a derogatory phrase people use for this kind of guidance from the Fed, or this kind of approach to solving this problem. But is that the wrong way to think about it? Is “stretch and pretend” actually the way to get us out of this mess?
A: Let me tell you this: I think some well-known financial experts have stated that this was not material to the macro economy. And I’m not sure that’s the case. When I think about the impact of that on the regional banking system, mainly suburban USA, we’ve had Silicon Valley bank pull back, we’ve had Signature bank hold up, we’ve seen First Republic pull back. If we have a systemic problem in the regional banking system, the unintended consequences of that can be catastrophic. Plus, what will happen when real estate values drop? 70% of all revenue in American cities today comes from real estate. So all of a sudden you start demolishing these buildings and putting them into foreclosures, the financial tap just comes off, right? Suddenly, tax revenues plummeted. Well, what happens is, you’re talking about the firefighters and the cops and the teachers in Main Street, USA, and at the end of the day, we’ve never experienced something as loud as this. And we have to be very careful, that we don’t tip over a building that we think is really stable.
