The Commercial Real Estate Bubble Has Finally Burst

The Commercial Real Estate Bubble Has Finally Burst

Heavy exposure to Commercial Real Estate (CRE ) is a significant risk faced by regional banks.

On Tuesday, the stock of leading regional banks such as PacWest Bancorp (-39.3%) and Western Alliance (-22%) sharply declined as investors assessed the financial health of regional banks following the sale of First Republic and the commercial real estate meltdown. We predicted last week that PacWest is in big trouble because of the meltdown in commercial real estate.

First Republic’s sale represents the second bank failure in just few months, following the collapse of SVB Financial in March. JPMorgan outbid PNC Financial and Citizens Financial for the lender and wealth manager’s $173 billion loan book and $92 billion in deposits, but the sale did not include the debt or preferred or common stock of First Republic.

Source : Bloomberg

The valuation of First Republic’s loan book may be causing mark-to-market adjustments at other regional banks. In addition, the Federal Deposit Insurance Corp. (FDIC) suffered a $13 billion loss on the sale, which it arranged with the California Department of Financial Protection and Innovation. This adds to the $22.5 billion in losses related to the collapse of SVB Financial and the closure of Signature Bank in March, leaving the FDIC’s Deposit Insurance Fund with a $35 billion shortfall that will need to be filled by higher fees from domestic U.S. banks.

But the main reason behind the fall of regional banks is the meltdown in commercial real estate market.

Distressed commercial real estate debt in the United States surged to its highest level in 14 years, reaching 5.3% in April. This increase can be attributed to the ongoing trend of rising interest rates and the persistent shift towards remote work, which has put pressure on landlords and the banks that have lent money to them. This development is potentially concerning for both parties involved.

Out of the 4,800 banks in the US, half of them are reportedly insolvent, with liabilities that exceed their assets. The current banking crisis is compounded by an impending commercial real estate crisis, where $1.5 trillion in loans must be refinanced over the next two years and could be impacted by rising interest rates. The actions of the Fed, which operates as a private cartel under the guise of a public entity, is responsible for these developments.

Read More about Commercial Real Estate Bubble

Commercial Real Estate Lenders See Drastic Size Reduction

Challenges Loom as $900B in US Commercial Real Estate Loans Approach Maturity

Commercial Real Estate (CRE) Market Plunges into Meltdown as Investors and Lenders Recoil

As Commercial Real Estate Market Struggles, Blackstone Falls Victim to Meltdown

Commercial Real Estate (CRE) Bubble Ready to Burst: Is Another Financial Crisis Imminent?

PacWest and Blackstone are not the only ones who are in trouble. Regional banks like KeyBank, Charles Schwab, New York Community Bank (NYSB), Old National Bank, OZK, Bank United, and many more regional banks have heavy exposure to commercial real estate.

Similar to the residential space, the problems in the commercial sector have arisen due to inflated prices that are now deflating, leading to higher interest rates for financed reinvestment or new purchases. However, unlike the residential space, the commercial market is experiencing an oversupply of space due to remote work policies prompted by the COVID-19 pandemic.

Last Month, Blackstone Inc. announced a 36% drop  in first-quarter distributable earnings compared to the same period last year, attributing this contraction to a weak commercial real estate market.

Morgan Stanley reports that $1.5 trillion in commercial real estate debt will become due over the next three years, with a considerable portion unlikely to be rolled over, potentially leading to a 40% decline in price. With 67% of these loans held by regional banks, this situation may be much worse than the financial crisis of 2008, increasing the danger for smaller financial institutions.

Charlie Munger, the vice-chairman of Berkshire Hathaway, has warned investors about the significant challenges the US property market is facing and its potential to unravel if things go out of hand. In a recent conversation with Financial Times, the legendary investor expressed concern about the large number of “bad loans” in US banks that will be vulnerable when “bad times come” and property prices fall.

The size of Commercial Real Estate CRE debt. (in Billion Dollar)

The Commercial Real Estate Bubble Has Finally Burst

The above chart provide a breakdown of the types of commercial real estate (CRE) debt that banks are exposed to:

  1. $4.5 trillion in CRE mortgages on income-producing properties, which refer to properties that are finished and have tenants. These are the types of CRE mortgages that are most discussed when landlords default.
  2. $467 billion in construction loans.
  3. $627 billion in loans for owner-occupied properties that the Federal Deposit Insurance Corporation (FDIC) categorizes as commercial mortgages.

In addition, banks extend revolving lines of credit, senior unsecured bonds, and warehouse facilities to non-banks to temporarily finance their mortgage issuance until they can be securitized.

According to an analysis by Cohen & Steers, out of the $4.5 trillion of commercial real estate (CRE) mortgages on income-producing properties, banks held $1.73 trillion (38.4%), with the remaining 61.6% held or guaranteed by investors and government entities. This means that the $1.73 trillion in CRE debt is divided among 4,132 banks.

Looking at the bigger picture, which includes owner-occupied property loans and construction loans, banks hold a total of $2.25 trillion, or 45% of all CRE mortgages. Specifically, the top 25 banks hold $700 billion (14%) of CRE debt, which is approximately 4% of their total assets. The next 110 banks, with assets ranging from $10 billion to $160 billion, hold $800 billion (16%) of CRE debt, while the remaining 4,000 smaller banks hold $750 billion (15%) of total CRE debt.

The last two categories of banks, regional and smaller banks, account for 4,110 banks, and they have a relatively higher exposure to CRE. On average, these banks have 20% of their total assets exposed to CRE. Among the 4,000 small banks, a few of them have exposure to CRE that exceeds 50% of their assets. If they face any issues related to CRE, they may end up joining the list of failed banks, such as California-based Silicon Valley Bank (SVB), New York’s Signature Bank, First Republic, and Credit Suisse.

Response of Federal Reserve and FDIC is nothing but devastating

The response of the Fed and the FDIC to the regional banking crisis is leaving shareholders in the lurch. In an effort to avoid being perceived as offering “bailouts,” regulators seem to be favoring the growth of larger banks. By supporting only big banks like JP Morgan and offering them favorable deals, the Fed is wiping out regional banks. While this option may be seen as safer in the short term, it carries the risk of placing control of the financial system in the hands of just a few banks. The top 15 banks already control 75% of US deposits, and this figure is expected to jump to 90% or more in the near future.


Leave a Reply