It’s getting worse and worse in real estate
Jamie Dimon predicts more real estate banking problems… growing problems with multi-family commercial real estate… are lenders starting to repeat the same problems since 2007?
The commercial real estate market is deteriorating.
Regular Digest readers know that for months we have operated a “Commercial Real Estate Watch” segment to monitor this crucial sector of the US economy.
The same factors that led to a handful of bank failures this spring are creating cracks in the foundations of the $20 trillion commercial real estate industry. If defaults snowball, it will have a huge impact on the US economy.
Well, the stories are coming faster and faster.
Let’s start with Monday CNBC article with commentary from JPMorgan CEO Jamie Dimon
Here is CNBC:
Deposit runs have led to the collapse of three US banks this year, but another worry looms on the horizon.
Commercial real estate is the area most likely to cause problems for lenders, JPMorgan Chase CEO Jamie Dimon told analysts on Monday.
“There’s always an offside,” Dimon said during a question-and-answer session at his bank’s investor conference.
“The offside in this case will probably be real estate. It will be some locations, some office buildings, some construction loans. It could be very isolated; it won’t be all the banks.
Of course, it won’t be “all” the banks, but my bet is that they are less “isolated” than Dimon says.
After all, regional banks are responsible for the overwhelming majority of lending to the commercial real estate sector. Bank of America puts the number at around 68%. So, let’s assess how important this problem could be.
This comes from Dimon’s own analysts at JPMorgan:
We expect approximately 21% of outstanding office loans of commercial mortgage-backed securities to eventually default, with a loss severity assumption of 41% and cumulative forward losses of 8.6% …
Applying the 8.6% loss rate to office exposure, this would imply about $38 billion in losses for the banking sector…
Does it seem isolated to you?
We are already seeing some struggling banks reduce their exposure to real estate
Take PacWest, which we’ve highlighted here in the Digest these last weeks.
Shares of the bank have come under enormous pressure since March as banking contagion spread. As you can see below, investors have fallen nearly 75% since March 1.
Well, Monday came word that PacWest was offloading dozens of properties to Kennedy-Wilson Holdings, which is a large real estate investment trust (REITs).
Regional lender PacWest Bancorp said on Monday it had agreed to sell a portfolio of 74 home construction loans with a total principal outstanding balance of about $2.6 billion to a unit of Kennedy-Wilson Holdings.
PacWest said in a filing that it will also sell six other home construction loans with a total principal balance of approximately $363 million to Kennedy-Wilson…
PacWest is one of several U.S. regional lenders whose shares have been hurt by investor concerns about the health of the banking sector following the collapse of three banks since March…
But while being regular Digest readers know about this ‘regional office/bank’ disorder, the ripple effects are spreading now
So far, our analysis has focused on the “office” part of commercial real estate. But the sector is much larger than just the office.
Broadly speaking, commercial real estate refers to any property used for business purposes. So, it could be a single storefront, a large mall, a warehouse, or even residential properties with five or more units paying rent.
Let’s focus on these multi-family residential properties for our next story.
Yesterday, The Wall Street Journal published an article highlighting Jay Gajavelli, a real estate investor who built a rental apartment empire in Houston consisting of more than 7,000 buildings.
You might even know Gajavelli from his “double your money” real estate strategy on YouTube. From one of Gajavelli’s locations:
I never worry [the] the economy now. Even if [the] the economy is collapsing, I still make money.
Well, Mr. Gajavelli, I would like to introduce you to the reality.
In April, Gajavelli’s company lost more than 3,000 apartments in four foreclosed rental complexes, one of the biggest commercial property booms since the financial crisis.
Investors lost millions. Gajavelli did not respond to requests for comment.
His company had taken out commercial real estate loans with floating interest rates that adjusted monthly. These types of loans in 2021 offered starting rates as low as 3.5%.
That all changed when the Federal Reserve started raising rates last year, driving up monthly loan payments.
Inflation contributed to the increase in spending, and [Gajavelli’s company] couldn’t raise rents fast enough to keep up. After the bills went unpaid, the company’s properties were seized.
Do you think Gajavelli was the only one to take variable rate loans?
Of another WSJ article from earlier this month:
… Home buyers have taken on unusually high variable debt during the pandemic.
In 2021 and 2022, the share of floating rate loans in total CMBS issuance was around 60%, according to data from Trepp.
In 2005 and 2006, when interest rates were also rising, the share was less than 15%.
There’s no way around it – more defaults are coming.
To illustrate, let’s go back to our original WSJ article:
Gajavelli is one of thousands of real estate contractors in the United States known as syndicates. Many have faced similar financial pressures and own properties they can no longer afford.
From 2020 to 2022, real estate syndicators reported raising at least $115 billion from investors, according to a Wall Street Journal analysis of Securities and Exchange Commission filings.
So far, faults have been rare. But real estate analysts and real estate investors anticipate a wave of foreclosures to come…
Many syndicators are rushing to raise money or sell properties before they tip into foreclosure.
Most hold lump sum loans that are due to be repaid when due this year or next. These syndicates face large payments at a time when it will be difficult to obtain new, more affordable home loans.
Even companies with multibillion-dollar portfolios have used syndication to buy apartment buildings that no longer bring in enough money to cover debt payments, bond documents show.
But don’t worry – I’m sure the problems will be “isolated”, just like Dimon says they will be for the banks.
Speaking of banks and real estate, the idiocy repeats itself
Remember the whole housing crisis of 2007 that nearly wiped out the US banking system? Do you remember what caused this?
In large part, it was banks that provided risky loans to subprime borrowers.
But we have learned, haven’t we? It is out of the question that our credit institutions repeat the same mistake…
Well, feast your eyes on this delicious MarketWatch Tuesday headline:
Homebuyers will now be able to deposit as little as 1% on their home, says Rocket Mortgage
And I know that makes you nervous, but don’t worry! This is in no way, shape or form like the “no down payment” mortgages in the subprime mortgage crisis. After all, it’s a huge “1%” down payment. See? That’s miles above 0%!
Rocket Mortgage CEO Bob Walters assures us that borrowers will have to meet “rigorous” credit standards. In fact, Walters is so certain that nothing can go wrong here, that this new 1% loan doesn’t even require borrowers to pay for mortgage insurance. Rocket Mortgage will pay it for you!
(Is it relevant that Rocket Mortgage reported a net loss of $411 million in the first quarter?)
I hope it will work, but I’m suspicious. Whatever the specific outcome, looking wider, there are more spin-offs to come. Unfortunately, real estate is so vast and so intertwined with complementary sectors that there will be collateral damage – we just don’t know exactly how much, or where.
Please be careful.
Have a good evening,