Why commercial real estate loans might never be the same again
Recessions and financial crises often have a way of changing the banking landscape due to the conclusion of agreements and new regulations. But they can also have an impact on the way banks lend. For example, after the Great Recession of 2008, banks focused much less on residential mortgages, historically their daily bread, due to the large-scale problems that arose in the housing market. A long period of low interest rates designed to stimulate the economy has made the yield on residential mortgages much less attractive. Collectively, the volume of residential (single-family) mortgages outstanding at U.S. banks increased from $ 2.7 trillion in 2006. to $ 2.5 trillion at the end of 2019, according to the FDIC
During the same period, the volume of commercial real estate loans (CRE) increased from $ 886 billion to $ 1.5 trillion. So there are a lot of CRE loans that really haven’t been stress tested during a recession, let alone during an event like the coronavirus. A CRE loan is generally granted to a borrower or a business to secure real estate for their business. Examples include buying a storefront for a retailer, an office building for a business, a large building for a hotel, or an apartment building that houses more than four units. Even though I think restaurants and hotels will bounce back from the Coronavirus pandemic, other types of commercial real estate will never be the same again due to the digital and distant trends that accelerated during the coronavirus.
One sector within CRE that seems likely to be permanently disrupted is that of offices. In a seemingly huge shock to the business community, workers who spend all day on their computers making phone calls can actually do the same job in the comfort of their home or in a cafe (shocking, I know). The coronavirus has provided the ultimate proof that employees can work from home and stay productive. This has led many businesses to start rethinking how much physical space they need.
“I’m worried about the demand for office space in major cities across this country as their leases come in. Rather than needing 200,000 square feet, they might only need 150,000 square feet as they will allow their workforce to work from home two days a week versus five. days a week in the office, ”said Gerard Cassidy, managing director of equity research at RBC Capital Markets, on the Kafafian Group banking podcast.
This shift is already happening with tech giants like Twitter (NYSE: TWTR) and Facebook (NASDAQ: FB), who said much of their workforce will likely be moved away after the coronavirus. In addition, a recent survey by research firm Gartner found that nearly three-quarters of the 317 CFOs and CFOs surveyed in March planned to move at least 5% of their employees who normally work in the office to remote positions in permanently after the coronavirus. Another survey conducted in late April by the corporate real estate association CoreNet Global showed that 69% of corporate real estate association members expect their business to reduce the footprint of their offices after working remotely during the pandemic. A month earlier, that number was 51%. Cassidy sees the office space industry change structurally over the next three to five years, something no one would have predicted before the coronavirus.
This could be a problem for existing office loans. If the demand for office space declines significantly, the value of office buildings could also decline. In this case, borrowers may not want to pay their monthly mortgages because they are now making the same high monthly payment but getting less equity on the property, a scenario that usually results in a loss on their investment. If this happens, or if the owner of an office building does not repay the loan, the normal course of action for a Bank is to enter and seize the property and then sell that building as quickly as possible to collect what is left on the loan. But if the value of the building drops enough, the sale of the building may not be able to make up the difference on what’s left on the loan. A similar conundrum occurred during the Great Recession, when nationwide home values fell dramatically.
Other CRE zones
It’s not just the office space that could be affected. After all, if people can work anywhere, do they have to pay rent and high house prices in Boston, New York, Los Angeles, and San Francisco? This could impact the demand for multi-family loans in cities, which are used to purchase apartment buildings or complexes of more than four units that could be rented or sold. According to the FDIC, the volume of multi-family loans at all U.S. banks increased from $ 193 billion in 2006 to $ 458 billion at the end of 2019.
Before the pandemic, many banks also stayed away from lending to retailers, but this CRE segment could be even more in trouble once the pandemic is over. Retail sales in the United States are expected to decline 10.5% in 2020, according to eMarketer, while e-commerce sales have already jumped 18% this year. Does this sound like a trend that is going to return to normal? Retailers in the United States could close 20,000 to 25,000 stores this year, according to Coresight Research. More than half of them could be in shopping centers. Historic department stores with huge brand recognition like Neiman Marcus and JC Penney (OTC: JCPN.Q) have filed for bankruptcy.
What will the future look like?
As digital and remote trends have accelerated, I still believe they are currently in an extreme scenario. People will not want to live their entire lives inside their house. A more likely scenario on the office front is that businesses provide a smaller, more cohesive space. Cassidy said he can see many offices losing their cubicles and individual desks and becoming open spaces where everyone can connect. Personally, I think there will be a lot more coworking spaces and different companies sharing the space to save costs. So CRE may not collapse like the real estate market did in 2008, but it is likely to change.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.