Things could get uglier in the commercial real estate market over the next two years as sky-high vacancy rates force a reckoning for office space and property owners try to refinance $1 trillion in debt coming due over the next five years.
But the market shouldn’t enter a “doom spiral” that craters the larger economy the way the housing crash did in 2008, according to leading experts on commercial real estate speaking at the National Association of Real Estate Editors meeting in Las Vegas this week.
“We do have problems, but they are local rather than general,” said Richard Barkham, global chief economist with the commercial real estate firm CBRE.
For starters, the value of the residential real estate market, which sank the economy in 2008 is around $43 trillion, while the entire commercial real estate market is worth about $21 trillion, Barkham said.
And not every class of CRE is hurting. Industrial is doing well, hotels have recovered and retail space is hanging in there. And while apartment developers may be adding too many units in the short term, there is a longer-term housing shortage that should eventually soak up that supply.
The pain will be mostly concentrated in office space, with about 15% to 20% of the current office supply obsolete given current demands, Barkham said.
One cause of concern has been the rising concentration of commercial real estate debt on the balance sheets of smaller commercial and regional banks. But that isn’t a case of bankers throwing caution to the wind, said Annie Rice, a managing director in the Los Angeles office of JLL Capital Markets.
“More deals are happening in smaller markets,” Rice said. “The market was shifting away from big coastal markets.”
Barkham did an analysis of the commercial real estate debt concentrations of the country’s 4,800 banks and estimates that in a worst-case scenario about 311 would fail based on a drop in value in the collateral backing the loans they extended.
Combined, those banks have assets equivalent to about three Silicon Valley Banks. It wouldn’t be pleasant, but it also isn’t on the scale of Lehman, AIG and Washington Mutual failing.
“This will be a problem for bank earnings,” he said. But it won’t be enough to bring down the banking system.
One key way the contraction in bank lending could hurt commercial real estate is a contraction in the credit lines extended to debt funds, said Jim Costello, chief economist with MSCI. Although it isn’t entirely clear what is happening there, there are reports that some funds are being cut off.
But Costello notes there is plenty of capital waiting on the sidelines and private equity firms are raising money to purchase distressed debt and assets. The difficulty right now is that the market hasn’t found a “clearing” price where both sides are willing to deal.
“There is another shoe to drop on pricing,” Rice said. But once those shoes start dropping, there is plenty of capital willing to step in at the right price to prevent the bottom from falling out.
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