Commercial Real Estate Probably Won’t Crash

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We’ve been hearing for several months now how the commercial real estate market is going to crash and how essentially the world will end because of it.

This is of course from the same people who screamed that the residential real estate market was going to crash. Sigh, it’s all so tiring.

Ok, let’s take a closer look shall we? This is courtesy of an article on CNBC and a recent episode of BiggerPockets where the Head of Real Estate Strategy at Cohen & Steers was interviewed.

The Commercial Real Estate Market

It is estimated to be a $21 trillion market. That’s enormous!

You shouldn’t just lump everything together and call it Commercial Real Estate because this asset class is so large and varied that it makes little sense to do so.

It’s comprised of various subsectors such as industrial, warehouse, senior living facilities, multifamily, offices cell towers etc…The vast majority of these sectors are doing really, really well.

Ask anyone who works in healthcare, needs warehouse space for ecommerce, or own apartment units – business is booming.

picture of commercial office space

Office Space Crashing?

The subsector everyone is focusing on is office space, and rightfully so. Since the pandemic introduced the work-from-home generation, there have been reports of vast office space in coastal cities such as San Francisco that are wastelands.

The issue is that since interest rates have risen sharply, when these short term loans come due, the owners will have to refinance at much higher rates, while also dealing with vacancies. Let’s see why this may not be as big a deal as people make it out to be:

Let’s unpack this:

Size of the Problem

In the residential real estate world, we’re used to long term loans, like 15, 20, and 30 years. In commercial, things are different. Loans are much shorter, like a 7 years loan for example.

These loans will come due/mature gradually over the coming years. It’s estimated that:

  • 2023: 16% of loans due
  • 2024: 14% of loans due
  • 2025: 12% of loans due

Of the 16% of loans due in 2023, it’s estimated that office is around 25% of those loans – commercial mortgages.

40% of these loans are from multifamily and that sector is doing pretty well. Tenants keep paying their rent and the past two years has seen a large increase in equity.

Again, if you want to know how the vast majority of commercial real estate is doing, talk to the people on the ground, the healthcare workers, the loan officers at banks etc…

picture of commercial empty space

Bank Exposure is Diversified

“To date, banks have had virtually no losses on commercial real estate, and companies are showing little need to default either on loans to banks or rent payments to office building owners”

-Marc Holliday, Head of New York’s biggest commercial real estate firm

Ok, what about the banks and mortgage lenders? Large banks don’t have much exposure to commercial real estate mortgages, it’s mostly smaller regional banks.

By the way, some banks like JP Morgan, Bank of America, Wells Fargo etc…have been deemed too big to fail and the government will literally step in to prevent a crisis, but again, these large banks have little commercial real estate exposure anyway.

Small banks: There are nearly 5,000 regional banks. That’s alot. The number one rule in spreading risk is diversification. The fact that these loans are spread across thousands of banks is encouraging.

Commercial Real Estate has alot of Equity/Low LTV

Ask anyone who has bought commercial property. You have to make a LARGE down payment. often 20-40%.

You’re not getting away with a no money down or 5% downpayment. This sector is for the big boys and if you don’t have the cash, don’t even bother.

Secondly, the vast majority of properties experienced ridiculous appreciation over the past couple of years due to the pandemic boom so property values are up double digits, which means owners have a TON of equity in their property.

This basically means that property values would have to drop 30-50% before an owner is underwater on their mortgage. That is far worse than the 20% drop in values we saw during the 2008 crash.

In other words, that is highly unlikely!

Oh, and if for some reason it does, there is a TON of money sitting on the sidelines from institutional investors. Regular retail buyers like you and me won’t even get a whiff of a good deal before it gets scooped up.

Bottom line

Is there pain in the commercial sector? Absolutely. We’re not denying that. And there will likely be even more pain. But things are never as bad (or as good) as they seem.

We just don’t want people to get scared from buying real estate yet again as we go through the normal up and down cycles of real estate.

The only way we can see that this ends badly is via a deep recession where there are massive layoffs across every single sector of unemployment.

Ironically, this may actually be good for real estate because the Fed will then lower interest rates, which may start the boom cycle all over again.