The sky is falling. If you are in the office industry that is what the world seems to be screaming at you. There are so many people assuring us about the coming bloodbath for office properties that it can be hard not to agree. This week the world’s most polarizing engineer, Elon Musk, gave his opinion in a reply tweet: “Commercial real estate is melting down fast. Home values next.”
One of the world’s most renowned investors also weighed in. Berkshire Hathaway’s Charlie Munger went on the record by saying, “A lot of real estate isn’t so good anymore. We have a lot of troubled office buildings, a lot of troubled shopping centers, a lot of troubled other properties. There’s a lot of agony out there.”
If that wasn’t bad enough, the head of one of the world’s most powerful financial institutions, J.P. Morgan Chase penned an op-ed in the Financial Times about how “Commercial property’s big reset will present opportunities.”
With all of this pessimism about the future of commercial real estate, the office in particular, it is hard not to agree. But if we were to just put our earmuffs on and look at what the data is telling us, it might be a different story. If the real concern is that buildings will not be able to pay for their debt then we should use buildings that have gone into foreclosure or special servicing as an indicator.
At first glance, the foreclosure data is alarming. It is up almost 70 percent above what it was last year, which is obviously a bad sign. But zoom out and we see that last year had historically low foreclosures and the current increase is still less than one percent. To put that into perspective the commercial property defaults at the height of the great recession were right around 9 percent and were even higher, to over 12 percent, during the savings and loans crisis in the early 90s.
There has been some anecdotal evidence of large office buildings going into foreclosure. Some of the most talked about have been the Bank Company and 777 Towers in Los Angeles owned by Brookfield. But these are a tiny portion of the office stock. In fact, they are not even a significant portion of Brookfields $800 billion of assets under management.
I am not saying that the upcoming commercial real estate debt maturing isn’t a problem, it is going to cause a lot of financial pain to building owners who need to refinance in this high interest rate environment. But I do think that we have not seen evidence yet that the maturing debt will cause foreclosures. We certainly could be sitting on a ticking time bomb of the twenty-some-odd trillion dollars of commercial real estate. But it is also possible that most of the industry is ok with weathering this storm.
Commercial real estate is a conservative industry. Loan-to-value ratios have a lot of padding for downturns. Investors in commercial properties are also well-capitalized and patient. Taking on higher interest rate loans might hurt the profitability of many buildings, but most will probably still be above water. If the interest rates get bad enough to actually spike commercial foreclosures, then we could have cause for concern. But until I see evidence of this happening at scale, forgive me for not worrying too much about the sky falling.
Overheard
Mapped
For a better visual of exactly how low commercial foreclosures are right now compared to the past few decades, check out this graph of Fed data.
What we are reading
Jet setting
A strip mall landlord has been accused of misusing investor funds for everything from a private jet to $100,000 birthday parties for his Boston Terrier.
B-ware
The head of Goldman Sachs’ Global Real Estate Financing Group explained her views on the future of the office well: “I don’t think we have an office problem – I think we have a ‘b office’ problem.”
IMAX offices
The future of the office could be “experiential” and offer workers something they could never have at home, much like IMAX movies.