Source: Wolf Street, by Wolf Richter
Commercial Real Estate’s boom-and-bust cycle heads south.
Commercial real estate’s eight-year boom reached such breath-taking levels that even the Fed has been pointing it out as one of the reasons for tightening monetary policy. The Fed is worried because of the size of the sector, its leverage, and what it did to the banks during the Financial Crisis. And now commercial real estate prices are heading south once again.
Green Street’s Commercial Property Price Index, which tracks the value of property owned by real-estate investment trusts, fell 0.4% in May to the lowest level since May 2016:
This is not happening because there is some sort of crisis. And this is not a crash, as during the Financial Crisis, when the spigot was suddenly turned off and liquidity disappeared overnight. Instead it’s a slow process that is happening despite super-low long-term interest rates, enormous liquidity in the markets, and super-easy financial conditions powered by yield-chasing risk-blind investors.
One of the primary drivers of the decline are the values of retail malls that have been getting hit by store closings and bankruptcies of their tenants as brick-and-mortar retail is melting down. So the sub-index for malls fell 2.8% in May and 5% for the past three months, and is down year-over-year. Other weak areas are apartment buildings. But industrial space – such as warehousing, one of the beneficiaries of the shift to online retail – remains strong.
Boston Fed President Eric Rosengren, one of the earliest advocates of unwinding QE, started warning about the CRE bubble last year. A couple of months ago, he gave a presentation on what CRE could do to “financial stability,” with some stunning charts.
The “significant decline in collateral values” of both commercial and residential real estate was “the root cause of the financial crisis,” he said. Currently, financial institutions hold $3.8 trillion of CRE loans:
- Banks: $2.02 trillion or 53% of total
- Life insurers: $460 billion or 12% of total
- Government Sponsored Enterprises (such as Fanny Mae) and Agency commercial mortgage-backed securities: $521 billion or 14% of total
- Non-Agency commercial mortgage-backed securities: $544 billion or 14% of total.
In terms of the banks, it’s the smaller banks (less than $50 billion in assets) that are on the hook: they hold $1.2 trillion of CRE loans. Larger banks (over $50 billion in assets) hold $767 billion. In other words, exposure to a CRE downturn is going to hit numerous smaller banks least prepared to deal with it. And that’s what the Fed is worried about.