Sources Tell Me Some Messed Up Stuff Is Happening in Commercial Real Estate
innovationnation.blog
innovationnation.blog
> They say the largest property companies in the US (they named names, I can’t) are raising huge amounts of money... if they stop paying the loan, and the bank gets the building back, the bank cannot sue them for the remainder of the loan.
For this reason, banks generally do not loan more than what the building is worth. Banks aren't dumb, they're not going to fall for something as obvious as this.
> Banks will take hundreds of billions to trillions of dollars in losses. And literally everyone knows the US government will have no choice but to bail them out, as usual.
Not really. They sure didn't bail out Lehman. And the owners of SVB lost all their equity. Bank owners do everything they possible can to avoid failing and being "bailed out".
> Then, when the banks turn around and sell these properties for pennies on the dollar, these same property companies that caused the problem in the first place are going to buy better properties for cheaper and end up better off than they were before.
Properties are sold at auction or similar and go to the highest bidder. It's certainly not "pennies on the dollar".
In sum, none of this makes any sense.
The building's worth was often based on pre-pandemic rent expectations. Lots of buildings are very empty these days, even if they're still currently leased. I wonder what the rates of renewals will be on suites where practically nobody goes to.
But I agree that the story as a whole made very little sense.
Raising money by issuing new shares wouldn't have anything to do with anything here.
When they go to buy the properties back, they'll be at the new valuations pricing in the fact they're probably going to have to offer significantly less rent than before to maybe get occupancy up. A lot of buildings have some pretty extreme valuations compared to how many people are actually coming in to the office.
I've heard of >200,000sqft buildings leasing for $30-40/sqft with only a few hundred people actually coming in. ~$8MM/yr+ in leasing for like maybe 500 people to come into an office most days in a week. That's $16,000/yr in leasing costs supposedly for each of those seats, before things like utilities and maintenance are figured in. Does >$16,000/yr per desk make sense to keep a lease?
I haven't heard those kinds of numbers just once. I've heard it (and seen it) several times. The office I go into has a nearly empty parking garage. It doesn't have the foot traffic to support the one cafe that used to be there. Whole floors are entirely open to be leased. I'm one of about four people who show up to the entire floor of the building.
Its crazy how empty so many commercial office buildings are these days. Personally I wouldn't mind seeing a lot of this commercial real estate take a bit of a haircut on valuations, hopefully we'll see rents dip a good bit and we'll see actual occupancy up meaning better usage of the things we've already built. Its depressing seeing tons of capital just sitting there unused based on some improbable dream of getting more in rent.
The idea is that real estate companies will walk away from all their current properties that are underwater, and default on the old loans. The banks have to offload the buildings for (supposedly) pennies on the dollar. These companies will snatch up those deals with the money they're hoarding now.
^- No new loans being defaulted on there.
So, where's the profit? It'd have to be from re-buying the same properties at well below fair market prices. Is that possible? Presumably in that kind of environment loans you can't get a loan for commercial real estate (so there's few possible buyers, only those with cash in hand) and at the same time the banks would be desperate to sell. So, sure, maybe the prices would temporarily be suppressed well below what should be the fair market price.
^- No new loans being defaulted on here either.
Again, I think the article is bullshit and flagged it, but you are misreading it and doubling down on the misreading.
My understanding a lot of commercial real estate is pretty highly leveraged with mortgages that only have a few year fixed rate. It sounds to me like there's a lot of buildings which are having significantly reduced incomes (fewer tenants) while their loans are about to get a good bit more expensive. For those with non-recourse loans, walking away in another few years might just be the only viable option assuming commercial real estate doesn't turn around.
I've got no opinion on whether the author here is full of it or not, but it doesn't seem entirely implausible to me.
Yes it does. It literally says:
> are raising huge amounts of money
Not "previously raised" but "are raising". That's necessarily "new".
And as I pointed out in another comment, issuing new stock would have nothing to do with anything. If the article isn't about acquiring new loans then it's not about anything.
This article is alleging they're putting together the funds currently. Not the taking out loans part, that'll come when they actually go buy the specific properties.
You don't get loans unless you've got the building under contract. You put together funds to start shopping for properties well before you actually put an offer on a building.
You ever buy a house? Do you take out a few hundred thousand dollar mortgage, then think about getting some cash for a down payment, and only then find a building? No, you align some cash for a down payment+fees and maybe some for repairs, then you maybe get a pre-qual for a mortgage, you sign a contract for a building and then finally get your loan.
The numbers and players involved change when buying commercial property, but that basic idea is still the same. This article states a number of real estate groups are gathering cash for the down payment and other immediate cash costs for the properties they and their friends already own. The author implies real estate companies are expecting property values to massively reset after they walk away from their properties and able to buy them back cheap at auction. Its only at the auction time that they'd actually have to get the mortgage together for the leveraged part of the building.
Raising huge amounts of money could be taking out new loans, true. It could also mean they're holding off on repairs andupgrades to their buildings or other expenses to hold on to cash. It could also mean they're talking to investors to put together new funds. And finally it could mean they're preparing to sell some stock at inflated prices for the expectation on some big windfalls in the future from having much better margins on rent versus their loans.
Nowhere in the article does it use the term "new loans", because chances are its not saying they're taking out new loans at this moment. Yeah, they probably would eventually get a new mortgage when they actually go to rebuy properties, but they're not at that stage yet.
But you're right, that interpretation wouldn't make any sense.
What does make sense, & fits the fact-pattern of recent strategic defaults on major commercial properties, is that:
1. they're walking away from older loans where they have this option, but…
2. simultaneously preparing warchests for repurchasing similar properties after an expected "fire sale", by all the banks that will soon be holding a glut of forfeited properties
It's not stated how real estate firms are "raising huge amounts of money". It's not necessarily new debt - but it could be, under different terms.
Just to take the recent default of "Park Hotels & Resorts" on two marquee SF hotels as a hypothetical: they've given up two properties with almost 3000 rooms, 9% of SF's hotel capacity, rather than service a $725M debt. It seems Wells-Fargo is the primary receiver.
Wells-Fargo is also under under stress from unrealized bond losses – but as a systemically-important bank, essentially immune from bankruptcy, & able to call on nearly boundless favors/liquidity to avoid any such wipe-out of their investors/managers. They can wait it out, and/or cover arbitrary billions of losses on foreclosed properties – "drops in the bucket" – as long as they keep their political patrons happy.
And at some point, a company that – if not exactly "Park Hotels & Resorts" – is the same sort of highly-leveraged real-estate holding company buys 2 giant hotel properties back for a fraction of the prior loan amount, riding the next cycle up.
The open-ended guarantee to the banking sector has now been laundered into loss-covering subsidies for another politically-powerful adjacent sector. They're timing the market, but from a privileged position of both aggravating the real-estate cycle and partnering with the money-monopolists running a longer financial-crisis cycle. "Everybody" (who's close to the boundless guarantees) wins!
"Well, you have to understand how their loans are structured. They are called “non-recourse.” What that means is if they stop paying the loan, and the bank gets the building back, the bank cannot sue them for the remainder of the loan. So they can just cleanly walk away with little to no cost.
What they are planning…is to walk away from any buildings where the loans are worth more it makes sense to pay or to refinance. En masse.*
Banks will take hundreds of billions to trillions of dollars in losses. And literally everyone knows the US government will have no choice but to bail them out, as usual."
Is talking about existing loans. If the loans are structured as described, then the commercial real estate company can walk away losing only the current buildings, while maintaining their cash reserves.
This part of the article is an allegation that needs backup, but if you could pull it off would make you an entrepreneur of the first class.
"Then, when the banks turn around and sell these properties for pennies on the dollar, these same property companies that caused the problem in the first place are going to buy better properties for cheaper and end up better off than they were before.*"
Historical evidence suggests otherwise. Obvious bullshit like this was the root cause of the 2008 housing collapse. As long as your bank isn't the one sacrificial goat the government chooses to let fail you will be fine.
This is the same thing that happened to residential housing markets in the S&L and subprime mortage crises, right?
It's true they're "not dumb" - the "systemically important banks" know they can take a chance on a sectoral or cyclical collapse like this, because the government won't let them all fail together. The downside is capped, but the leveraged upside arbitrarily larger.
While wiping out SVB's shareholders, the government launched special programs (like "BTFP") to help all SVB's peers with artificially-cheap money requiring less collateral than ever before. That's a stealth & incremental bail-out – which could paper-over the problems, or worsen them, depending on other economic developments.
If commercial real estate broadly crashes, those banks will unload these properties they don't really want – as even the commercial real-estate pros couldn't make them profitable – at potentially-severe discounts to the unpaid loan amounts. If these discounts are anywhere near 50%, then "pennies on the dollar" would be a fair description. I guess time will tell.
Might be true. But everything they can is not enough.
First, there’s the principal-agent problem: the owners (aka share holders) can not fully control managers or staff in general.
Second, the goals of an organization do not necessarily align with the goals of the individuals that contribute to the organization. For example, young bankers who know that they will switch jobs some time will work differently than those who also own the bank. So usually there’s a bias towards more short-term profit and higher risk.
Also for the bank as a whole there’s a bias towards risk because they have to compete with other banks. If I’d be a well-intentioned CEO I would still be forced into that behavior because otherwise I would simply be fired or the bank would lose against other banks.
Obvious (if politically impossible) fix - banks that go bust become U.S. Gov't. property. Bank executives are fired as unneeded/incompetent, and their stock options become worthless paper. U.S. DoJ gets nasty about clawing back recent executive bonuses, compensation, and such.
the assets should become government property and administered long enough to sell off the assets to the market.
the bank itself should be dissolved as a legal business entity, with no protection for the executives
Im also not really optimistic anyone will stay angry enough for anything to happen. The news cycle burns so hot right now that people seem to be OK with paying almost double for food and still people are like “ooh but theres so much content”.
The market is currently on a blind bull run stampede because too many retail are short and holding puts or outright shorts. This was exacerbated few months back when Burry tweeted "SELL" and millions or retail traders straight out started shorting stocks and buying puts.
SPX and TSLA is running up for absolutely no reason beyond their wildest EPS just to bankrupt the retail. I suspect it will keep running for months until all the retail have either bought in to the bull run or died of trying to short the market.
When that happens is when the music stops for this game of musical chair.
But that's a hyper specific view point that I doubt many hold, but I feel like that's the view the author has.
The disgusting part is where taxpayers make the banks whole for their commercial real estate losses! It is a multi-billion taxpayer bailout of private corporations.
Losses cause crunches elsewhere, via the taxing/printing/managed-decay policies which buy the banks an unlimited number of get-out-of-bad-decisions-free options.
Who finally pays is left as an exercise for the reader, both figuratively & literally.
So even if "the bank fails", there's been destructive speculative misallocation whose social costs can be far larger the nominal owners' losses.
Of course, the government also doesn't let the "systemically important banks" fail - so related politically-mobbed up interests don't even get "wiped out".
What I want to know is: is it possible to find out how many of these commercial loans contain a "non-recourse" clause?
definitely interested in this topic for practical reasons here in California
You mean occupancy rate right?
First of all, if it's done intentionally, it's fraud. And if two people have blabbed to random Substack guy, then this would be easy to prove.
Secondly, what exactly is the strategy here? Borrow a ton of money to buy buildings, then default on them and walk away? Where's the profit exactly?
Third, the firms capable of raising this level of capital also care about their reputation and ability to borrow money in the future.
And finally, the buildings won't be worthless when the bank takes them over, they'll just be worth less. To lose trillions here, this would have to happen on a scale of $10 trillion or more? The entire commercial real estate market in the US is only worth like $20 trillion.
Admin fees
But it's far from impossible!
A 10% drop would be enough to deliver (2) "trillions" in losses to a ~$20T sector - & broad commercial-real-estate price indexes often show swings of 15% or more within a year. Since then end of 2021, major indexes already show a 15% drop with no hint of slowdown - and from 2007-2009, there was a broad ~40% drop.
If there's a 2008-style crash – and it seems likely much of these losses, whether strategic no-recourse defaults, or simple inability-to-pay defaults, will pass through to banks – there could be $8T in losses.
- Westfield Mall: https://twitter.com/rolandlisf/status/1668356986256375808
- 2 major downtown hotels: https://sfstandard.com/business/real-estate-group-halts-loan... (with more likely to follow)
In a world of remote workers without retail, commercial real estate has taken a big hit.
In my area, that means that there are 4 malls that are planned for demo, and one with a lot of vacancies, not to mention untold strip malls ready for the same fate.
These properties are all being rezoned to mixed use or residential development. All of them.
The company has three core activities:
1. Raising money from investors 2. Buying properties when the price is less than the expected profits. 3. Selling properties when the price is more than the expected profits.
At a point a year or two or three ago, the math on buying properties just stopped making sense on individual property basis. That whole side of the business just ended up going into sleep mode. No purchases since forever. However selling properties (adding cash), and fund raising (adding cash) kept right on going. The net result is the company owning only a small percentage of what it used to own, but having one heck of a war chest. Which they are sitting on, waiting for the economics to make sense again.
it was considered safe because a commercial tenants was likely trying to run a stable business and moving location is very expensive, so it was unlikely for a business to want to change location on a whim.
I still doubt the whole scenario. I hope some emergency regulations to turn empty commercial real estate into housing is passed, I know it’s not ideal, but it’s not impossible.
A busted deal isn’t a happy outcome for a real estate developer, at all, and they lose whatever equity they invested on the project, but non-recourse debt protects them on the downside and they make their real money on the successful deals.
But back in reality, of course we all know that the commercial real estate market is by and large looking at a world of hurt. But I think by and large they’re going to muddle through. Some developers will lose their buildings, equity is definitely taking a hit and there will surely be some losses on loans. But on balance, I think the banks will be fine (and some fulcrum security holders somewhere in the capital stack will find themselves owners of, in some cases, VERY nice new buildings).
I worry less about the debt lended to finance these building than I do about the many, many pensions, retirement systems and insurance companies that rely on a structured equity return to meet their long term financing needs.
Free money led to overbuilding restaurants and offices. This is a correction, value is lost and companies will go under. The remaining industry will match the remaining demand.
But the 1st part of this story fits recent trends in SF's commercial market, with some high-profile loan-walkaways on marquee properties.
And it fits history, where deep-pocketed investors are happy to see many kinds of asset crashes – if they've kept their "powder dry" – to snatch up valuable properties at lows.
Do you think people running this strategy want it to be widely understood?