Would the Commercial real estate businesses crumble under their own weight ?

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Since a long time, the business of commercial real estate has known only one direction and that is going up. This accelerated rate of growth has primarily been fueled by debt money or borrowed money.
The working principle has been to borrow cheap and invest in commercial buildings. Be it malls or office spaces it all eventually goes up in price so the rental income can be used to pay the cheap debt.
More premium the property more the rent and the quicker it is to repay the debt.

COVID changed it all

COVID meant shut down of offices for an extended period of time. The COVID restrictions caused the workers to work from home instead of having to commute to work.
Suddenly the office space became redundant. Organizations discovered a new work culture of workers working remotely and often working from home.
This meant organizations no longer had to pay the rentals of swanky real estate the price of which was jacked up all the time.
Now there was a functional model of a team working remotely as one unit.

This was a great work revolution. Similarly the shopping habits of people evolved. People started shopping online for food and groceries. Since a lot of these deliveries could be carried out from warehouses and small outlets a prime location to set up shop was no longer required.

What did this do to the commercial real estate business?

Those who had their money invested in these premium office spaces and malls suddenly found no takers for their premium commercial real estate.
Their premium properties were being vacated and the already unoccupied ones found no takers.
The result was that there were no takers and these unocupied buildings meant no rental income for the owners.
This led to pressure to pay the debt from their own pockets.

Commercial buildings need money for maintenance and repairs

Commercial real estate that is a premium property needs a lot of money to maintain the premium look and its shine.
While this no occupancy game was being played out there was another thing happening and this was the interest rates kept creeping up.
This hit the owners in two ways one for those who had borrowed money on floating interest rates the money to be paid back kept going up.
Plus without low cost debt, the cost of borrowing to maintain the buildings has been going up too.
This means the commercial real estate business is being hit on a number of fronts

• No or dwindling demand for the properties
• Balance inventory with a high cost of maintenance
• No or little money to pay back the debt

How bad is the situation?

Looking at the numbers from USA alone the $1.4 trillion is the estimated amount that corresponds to the commercial real estate loans which are outstanding and due for this year and the next year.
These numbers come from the Mortgage Bankers Association.
This has created such a situation that outstanding loans may precipitate the situation. Looking at the bleak outlook the property owners may opt to default in place of paying the outstanding by way of taking more debt as the interest rates are already on the rise.

The big players may end up defaulting

Looking at the list of those involved names like Blackstone, Brookfield, and Pimco come to the fore.
These names have decided to stop payments as their business strategy as they feel their cash funds could give better yields elsewhere.

This can cause a lot of financial stress

This nonpayment of the debt and interest due may cause financial stress in the system.

A principal with Keen-Summit Capital Partners LLC at New York who is a specialist in renegotiating distressed real estate he says that it is not usual for people to give up on real estate. This only happens when they do not see any hope of recovery.

The overall commercial real estate scenario

The number of deals and transactions is going down.
Even the deals which are happening are at a lot lower prices. These deals are in the backdrop of the fact that how offices are working in USA

The workers are not returning to the office

In USA the return to work trend is slower than those seen in Europe as well as Asia.
This has seen the value of institutional office space go down since March 2022.
This was the time when the interest rates started going up and this has let to a massive 27% decline in value of commercial office space.

Let us look at some number

As per data analytics company Green Street
Apartment building prices declined by 21%
Mall real estate went down by 18%

How the trend is seen going ahead

As per PGIM Real Estate, a unit of Prudential Financial Inc., the forecasts show a picture that is far from rosy
This downtrend seems to be a global contagion and this decline is not limited to the USA alone.
In Europe office prices are expected to fall more than 25%
In Asia Pacific, the fall is expected to be 13%

The downtrend is severe, and the PGIM analysts have even named it as the great reset.
The pain is real and quite bad for this sector.
If we look at the 2008 financial crisis for reference then from there it took six years for the office space prices to recover.

Not just about commercial estate anymore

The commercial real estate sector would lead to a lot of financial stresses which is very much likely to be passed on to the financial system as a whole.
It may be noted that the financial system is already under stress owing to the crisis associated with the regional banks.

What if this freefall accelerates?

In such a case a lot more cities would see lots of empty office buildings with no takers and this would also impact the revenue collection for the property tax department.

Those involved in these businesses are big players with not only deep pockets but also with a lot of good connections.

Time would tell how they would be able to come out of this difficult situation or would they use there powerful connections to negotiate tax breaks of some sort?
As money and connections can makes a lot of things happen.

Posted Using LeoFinance Alpha