A lot of people have been waiting for “the other shoe to drop”, and now that day has arrived. Thanks to rapidly rising interest rates and historically low occupancy rates, we are facing an unprecedented commercial real estate crisis. Borrowers are starting to walk away from commercial real estate properties all over the nation, and that is really bad news for small and mid-size banks because they are holding most of these loans. Needless to say, a lot of small and mid-size banks are simply not going to be able to survive a nationwide tsunami of commercial real estate defaults.
When U.S. Senator John Kennedy was asked about this growing crisis, he didn’t mince words…
“Am I worried? The short answer is yes,” Sen. John Kennedy (R-La.), a senior member of the Senate Banking Committee, said in an interview. “The long answer is hell yes.”
“I hope the Federal Reserve and the banking regulators are worried as well, and I hope they won’t be caught flat-footed like they were with the bank failures that we’ve had so far,” Kennedy said.
In some cities, commercial real estate values have already declined by more than half.
As borrowers increasingly walk away from bloated mortgages, lenders are going to be facing a balance sheet shock of epic proportions…
As the federal government strives to contain financial market turmoil, the next risk looming over the nation’s banks is in plain sight: the $20 trillion commercial real estate market.
Some $1.5 trillion in mortgages will come due in the next two years, a potential time bomb as higher interest rates and spiraling office vacancies push down property values.
And because 70 percent of bank-held commercial mortgages sit on the balance sheets of regional and smaller lenders, a write-down in commercial loans could spell big trouble for the financial system and spill over into the larger economy just as the 2024 presidential campaign gets underway.
Of course we don’t have to wait for 2024, because many borrowers are already defaulting right now.
For example, Park Hotels and Resorts just announced that it will no longer make payments on “two of San Francisco’s largest hotels”…
The owner of two of San Francisco’s largest hotels has stopped making mortgage payments on the properties and will let them go into foreclosure as historic crime rates continue to deter tourists.
Park Hotels and Resorts announced on Monday that it stopped making payments on its $725 million loan due in November for the Hilton San Francisco Union Square and Parc 55 — the largest and fourth-largest hotels in the city, respectively.
Over the past few years the downtown area of San Francisco has rapidly degenerated, and Park Hotels and Resorts alluded to this in their announcement…
‘Now, more than ever we believe San Francisco’s path to recovery remains clouded and elongated by major challenges — both old and new’ as the city becomes a ghost town with empty storefronts.
‘Ultimately, the continued burden on our operating results and balance sheet is too significant to warrant continuing to subsidize and own these assets.’
Sadly, countless other businesses have also decided to leave downtown San Francisco on a permanent basis.
In fact, only about half of the retailers that were operating in the Union Square area in 2019 are still open today…
Out of 203 retailers open in 2019 in the city’s Union Square area, just 107 are still operating, a drop of 47 percent in just a few pandemic-ravaged years.
Among the heavy hitters, Brooks Brothers, Ray Ban, Christian Louboutin, Lululemon and Marmot have all packed it in.
In the end, lenders are going to be stuck with a lot of commercial real estate that is now worth far less than it once was.
Even if buyers can be found, the losses in many cases will be absolutely staggering. Recently, one very important office tower in San Francisco sold for “71% below the original asking price”…
Wells Fargo found a buyer for one of its office towers in San Francisco, the 13-story 355,000-square-foot 1960s-era tower at 550 California, across the street and around the corner from its headquarters tower on Montgomery.
Wells Fargo had purchased the tower in 2005 for $108 million. It is vacating the building. Last year, it listed it for $160 million, but then pulled the listing after receiving bids reportedly below $40 million. Earlier this year, it engaged real estate investment bank Eastdil Secured to relist the tower.
And it has now made a deal – the name of the buyer has not been disclosed – for about $42.6 million to $46 million ($120 to $130 per square foot), according to sources cited by the San Francisco Business Times. That would be 71% below the original asking price and nearly 60% below the purchase price in 2005.
As the U.S. economy slows down even more, this commercial real estate crisis will only intensify.
And of course this is all happening in the context of a global economic slowdown…
The World Bank said Tuesday that global economic growth has slowed sharply in the face of higher interest rates, chronic inflation and continued fallout from the banking crisis.
According to the World Bank, the outlook for the months ahead will be quite bleak as interest rates go even higher…
The threat of higher interest rates, and the possibility of more turmoil in the banking sector following a spate of bank collapses this spring, could slow economic growth even more this year.
“The world economy remains hobbled,” the World Bank said in the report. “Besieged by high inflation, tight global financial markets, and record debt levels, many countries are simply growing poorer.”
We really are in the very early stages of a global economic meltdown.
Inflation is out of control, interest rates are spiking, large companies are conducting mass layoffs, the global housing bubble is bursting, and we are facing a commercial real estate crisis that is unlike anything we have ever experienced before.
And the truth is that our economic problems are only just one element of the “perfect storm” that we are now experiencing.
I am very concerned about what the rest of 2023 will bring.
But I am even more concerned about 2024.
We are truly in unprecedented territory, and nobody is going to come riding to the rescue any time soon.
So buckle up and hold on tight, because we have got a very bumpy ride ahead of us.
Michael’s new book entitled “End Times” is now available in paperback and for the Kindle on Amazon.com, and you can check out his new Substack newsletter right here.
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