IS COMMERCIAL REAL ESTATE ABOUT TO IMPLODE?
In recent months, with interest rates rising, there has been quite a bit of chatter about the fate of America’s commercial real-estate market, which had already taken a considerable hit thanks to the COVID-19 pandemic. And with Silicon Valley Bank going under, other large financial institutions currently in turmoil, along with major commercial real-estate owners -- like Blackrock -- reportedly planning to default on their mortgage obligations, things are feeling a bit like 2008, when the housing-market crash rocked our economy.
And while a commercial sector implosion may not have the same implications as the housing crash had on the country some 16 years ago, one expert believes that Americans, by and large, will be the ones left “holding the bag,” if commercial real estate (CRE) takes an anticipated nosedive.
We had the pleasure of speaking with Richard Rubin, Founder & CEO of Repvblik, to discuss the state of the country's commercial real-estate sector -- where office buildings are experiencing high supply/low demand, and how that ugly reality will negatively effect our economy.
"There is an innate issue with commercial offices as a business case but also those holding the primary and secondary paper,” Richard explained. “Like 2008, you now have a wide swath of banks out there who are holding effectively toxic CRE mortgages. What happens when defaults start pouring in and the bubble bursts?"
Now you may be wondering how another “meltdown” could possibly occur, given that federal protections, like the Dodd-Frank Act, had been enacted some 15 years ago to protect the country from another wide-ranging financial crisis.
Well, believe it or not, the sweeping legislation passed post-Great Recession didn’t extend to the commercial sector. So, true to form, banks (and all other the risk takers, including some “less than honorable” actors within the financial system) found another way to exploit a vulnerability.
As Richard puts it, “The exotic dancers you saw in the movie The Big Short who had 5 homes [because banks were issuing mortgages with little-to-no credit history in order to repackage the loans and sell them to another bank a week later] are back, but the exotic dancers are now REITS” (or “real estate investment trusts”).
And while we’re certain Richard wasn’t intending to disparage exotic dancers, or the services they may legally provide, he believes REITS are now holding an incredible amount of paper backed by depressed commercial office assets, and that the looming debt obligations are likely in excess of a trillion dollars.
What triggered this latest bubble? Richard attributes most of it to the unexpected shift from all the old, in-person work models which were spurred by the coronavirus pandemic (with WFH, Zoom, and e-conference calls leading the way). And while extremely generous government stimulus and assistance programs propped up offices during the lock-down period, all the large retailers and commercial property owners assumed that the prior physical return-to-work paradigms would return to normal and that balance sheets would swing back upward.
But with employees liking the flexibility afforded by remote-work, and its elimination of commuting inconvenience and costs, and with their employers realizing that they no longer need lavish or expansive physical plants to “house” their workers or to entertain clients, that commercial “bounce-back” hasn’t happened (and doesn’t appear to be on the horizon anytime soon, either).
And while it may have been acceptable for loan holders to be indifferent to the true value of their assets during the three-year Covid-19 period (where government funds were still in play), Richard opines that, all the while, a tremendous bubble, which nobody cared about, was forming. “With 30-50% occupancy rates in these buildings, and non-recourse loans backing the paper, the proverbial ‘kicking the can down the road’ is over,” Richard concludes.
And he believes the handwriting’s been on the wall for some time now. Just look at the amount of subleasing that has occurred over the last couple of years – with some reports indicating that there was at least 47% of such activity occurring in buildings built between 2001-2022, and some 23% in buildings constructed after 2018. The values of those under-performing assets were just repackaged and resold, just as in the years leading up to the housing crash. “It doesn’t matter how complex those deals and packages were, if the assets are under-performing, it’s all the same," Richard noted.
So, some billion-dollar hedge funds made some bad bets and it’s time to for them to pay the piper, right? After all, they have all the money in the world.
Well, apparently, it ain’t that simple.
“Someone’s holding that paper,” Richard says, “and when those entities with the largest exposure default on their loans [with many of those payments coming due later this year] more banks will go under.” And the unfortunate thing for the rest of us, is that many of those portfolios were financed, or otherwise supported, by pension funds, and retirement plans, and the hard-earned dollars we, the American taxpayers, mistakenly invested.
Richard’s biggest beef with this default countdown is the lack of public attention. “The silence is deafening … but the ‘equity silence’ is because the original issuing lenders already substantially depreciated the value of the assets before shipping it off to the REIT markets.” In other words, the bad actors have already cashed out before they sold others entry tickets to the casino.
Regrettably, the dominoes have already started to fall, with Brookfield Corp, RXR, and Chetrit Group's $85M loan on Manhattan’s Hudson Yards site, already in default, and with many more expected to follow suit in the months ahead.
Fasten your seat-belts, folks! It looks like we’re about to head into quite a bit of turbulence ….
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Richard Rubin, a Principal of Repvblik and a lifelong entrepreneur, launched his first business after graduation from The University of South Africa at age 21. He was the founder and operator of an advertising and marketing agency for seven years.
In 2004, Richard began investing in real estate, which has been his focus the past 16 years. Initially, he invested in downtown Johannesburg, South Africa, and pioneered adaptive reuse of high-rise commercial office buildings into large scale affordable housing developments -- owning and managing 4,500 student housing units. Richard moved to the United States in 2015 and founded Repvblik with Chris Potterpin of PK Companies LLC.
Repvblik engages in adaptive-reuse of distressed properties, and is leading the charge in revitalizing under-performing commercial properties and breathing life into neglected urban areas across the country.
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