Bank Failures to DOUBLE on Coming Real Estate Implosion [CMBS Hell]

the Commercial Banking sector has a lot

of debt but it has a lot of one

particular type of debt and that is

commercial real estate debt and

unfortunately commercial real estate

hasn't been doing a super fantastically

mostly because of a return oh away from

work at the office that is we've seen

Office Buildings and Retail kind of

collapse in the needs that companies

have and now it's sort of weird because

post covid for example we saw shopping

malls like the Simon Property Group see

this Resurgence of traffic and we saw

offices reopen so you had this

Resurgence of traffic to offices but

unfortunately that Resurgence while it

may have been a nice retracement of

about 50 percent it quickly tapered off

and slowly continued to decline and that

is not great for people who hold

commercial real estate debt specifically

because in a rising interest rate

environment individuals or companies who

hold commercial real estate debt

generally have to refinance after a few

years that's because they don't have the

Privileges that home buyers do which is

the privilege of a 30-year fixed trade

mortgage now in some commercial settings

you could ask for a 30-year fixed rate

mortgage but typically you're paying uh

excessively High fees in order to get

that so instead generally what you're

looking at when you're looking at a

commercial style mortgage is you're

going to be looking at uh maybe

something some kind of debt that's

amortized over 20 years but then do in

three five or seven years I'll show you

how that looks on the iPad here so if we

jump in here and we say you take out a

loan of let's say 10 million dollars a

year uh zero and let's say that loan is

a three percent interest loan and then

time goes on and this loan is amortized

over 20 years which actually means after

year 20 it would be 100 percent paid

right but instead of actually making it

all the way to year 20. this particular

loan is going to be due and payable

after year seven this would be known as

a balloon payment where all of a sudden

you'd have to make a large payment on

the property probably somewhere in the

neighborhood of 60 to 70 percent of the

debt and what you would do in this case

unless of course you haven't been paying

down any principal and you'd have then

you'd pay down zero and you'd have to

pay down the whole load

so in this scenario you would need to

refinance well how does refinancing work

if your year 7 is potentially 2023 or

2024 well rates are expected to be uh

for somebody in this situation

potentially two to two and a quarter

times as high as they used to be that

makes it extremely expensive for

commercial real estate projects whether

they're office retail hotel or otherwise

to actually survive because now all of a

sudden properties that may used to have

been cash flowing properties are now

substantially cash flow negative and if

there's one thing we know we need in a

recession it's cash flow we want cash

flow we want money coming in uh more

money coming in then money is coming out

obviously it makes sense to uh you know

want more uh expenses or or to spend

more money on businesses or commercial

developments in a recession because it

could be an opportunity for you to make

money right you make an investment at a

low part in a market maybe that's the

perfect time to take advantage of fear

in markets and actually invest in your

business or your commercial real estate

the problem is in new commercial real

estate though or new business ventures

the problem is all the old stuff all the

existing malls all the existing offices

what's going to happen to them and how

bad could that end up being for the

banking system see if banks hold a

substantial percentage of commercial

mortgage-backed Securities and if those

mortgage-backed Securities potentially

start defaulting what kind of stress

could we actually see on the banking

system as a result of this well let's

analyze exactly that JPMorgan has a

fantastic piece on this from just about

a day and a half ago here and as you see

JPMorgan commercial real estate overview

and they talk exactly about the stress

in the banking system and we really

don't have to go too far we can they

give us a wonderful overview here but

it's it's a little slightly dense but

I'll give you a good summary here so so

the first page fantastic summary let's

start here commercial real estate is

very topical and top of investor Minds

due to weakness in the office Market

driven by work from home trends and this

to some extent is true we have a lot

more work from home now than we did

pre-pandemic although there is some

reversal to work from home and so it's

worth making a little note and I'm going

to help you answer this in this video

and it's also important for my real

estate startup house hack but keep this

in mind where is work from home

reversing right so where is it going

away where is that work from home Trend

going away and where is it going to

we're going to want to analyze that so

the concern is augmented by the current

weakness in Regional Banks and a wall of

maturing loans across the ecosystem

60 percent of mortgage-backed security

Bonds commercial are held by banks that

means banks have an acute exposure to

commercial real estate finally we're

also watching retail but clearly that

Outlook is a little bit more dependent

on the macro backdrop in this report

which we jointly published with our

colleagues at the SPG research we take a

top down and bottom-up view of real

estate and we estimate the total

exposure all right so according to the

Mortgage Bankers Association commercial

real estate Mortgage Debt outstanding is

roughly 4.4 trillion dollars in total uh

of which 38 of of commercial real estate

debt over here uh that's uh to be

different from these maturing loans is

with banks so take I want you to break

that apart for a moment because I know

that could be a little tricky so let's

break that apart

what they're saying is of remember how I

made that little chart of the ones that

were doing payable right all of a sudden

they have to refinance right of the due

and payables the maturing one all right

these are the maturing loans of those

60 are with banks

of the non-maturing which means they

still have time in them 38 are with

banks so in a weird way you actually

have a disproportionate exposure now

in commercial real estate at the banks

because of when most of these refinances

were conducted initially or initial

financing all right excluding

multi-family exposure total commercial

real estate is 2.5 billion of which 44

is at Banks U.S commercial Banks also if

they give us some numbers here but we

want to know what the pain is and and uh

where some of the investors are in this

right so life insurance are major

investors in commercial mortgages both

on whole loan and uh uh and Commercial

mortgage-backed Security broadly these

would be outside uh Banks you could see

Banks hold a lot more exposure uh than

life insurance life insurance holding

about 11 to 4 so relatively low but I

suppose of of a big number or a small

percentage is still a big deal uh and so

they gave us some good numbers here and

here are some of their expectations of

what they think in terms of default we

expect that about 21 of outstown

understanding office loans will end up

defaulting 21 default and JPMorgan is

going to write down because remember a

default just means you stopped making

your payment it doesn't mean that there

wouldn't be any kind of recuperation

right you wouldn't just lose 21 of all

that money and the reason is there's

there's still an asset left right when

somebody liquidates a property so let's

say you have a 100 million dollar

building and the bank forecloses on it

or whoever whoever holds the note

forecloses on it they might still get 70

million dollars after all is said and

done so they might only be upside down

in this case 30 right so just keep that

in mind that's why you might see a lower

loss ratio after default so if 21 of

commercial mortgage-backed Securities

default on office loans that could lead

to losses of about 8.6 percent now

that's actually really interesting

because uh and and these defaults could

potentially go as high as 28 to or to 35

leading to losses around 13 18 basically

office is going to have a big little set

of losses coming up now who owns most of

these losses well unfortunately the

banks now why is that bad well more Bank

losses on their mortgages and their

portfolios on their commercial mortgages

uh means less cash on hand for

depositors and we're experiencing one of

the fastest Bank runs that we've seen in

history part of that is driven by a

technological Revolution where it's very

simple now to look for a money market

fund or go to treasury.orak.gov and

invest in treasuries into a money market

into a CD into any fintech that's

offering you higher yields than the

large Banks so it's very easy to take

your money out of the large Banks put

put it into a Fint tank or a money

market fund and you could do that all

from the comfort of your phone you don't

even actually have to run to a bank

anymore

so while at the same time we're seeing

this liquidity drawdown we're also

setting up for potentially large

failures in commercial real estate

specifically in the office segment so

this is really bad

and they talk about separating uh REITs

here into two different buckets uh

they're separating them into property

owning Equity REITs and then commercial

mortgage rates and they talk a little

bit about uh read losses but they seem

to be less uh Salient or important than

um

uh than the office sector but they do

apply here a a loss on some of these

REITs as well and they attempt to

calculate some of the pain that could

happen here they do talk about how

potentially loss rates could be lower

because of banks willingness to amend

and extend loans

however that could be risky in the

environment of a bank run so uh let me

try to simplify that what they're saying

is hey look when we compare back to the

global financial crisis the great

financial crisis maybe back then Banks

were actually less likely to take losses

on their loans because they were willing

to negotiate payment terms

now that's really interesting because if

you can negotiate payment terms you

don't necessarily take the loss on the

loan but if you need to sell the loan

because your depositors are freaking out

then you're less inclined to negotiate

and you're essentially more likely to

foreclose because you need the capital

that's essentially a rough summary of

some of the argument that's being made

here uh and to some extent that's

actually scary

in addition to that Regional Banks today

are a lot more stressed which reduces

their ability to amend and consent to

loan modification see that's sort of the

idea here that hey look the more

stressed the bank is the less likely

they're able to work with you if you

default on your loan with the banking

system uh so the overall exposure ratio

to to uh to commercial real estate is

really high you can see these

substantial losses of uh tens to

potentially hundreds of billions of

dollars for banks and and why that's so

important is because think about this

the Federal reserve's Emergency

facilities combined with FDIC over the

last two weeks have essentially provided

around 300 billion dollars of liquidity

well that same amount of liquidity or

nearly that same amount of liquidity

could evaporate thanks to commercial

real estate valuations plummeting so

commercial real estate a massive factor

of potential pain that we're paying

attention to right now but it's not all

commercial real estate and I find this

really interesting

a lot of people talking about the next

shoe to drop this here is an interview

with Bloomberg and you've got two real

estate folks over at Bloomberg

discussing this they say a lot of people

are talking about the next shoe to stop

a next shoe to drop being on the

property or real estate side and

obviously there's a lot of concern about

exactly what's going on with Office

Buildings just the interest rates going

up in general tends to be bad for Real

Estate as a broader category so I think

this is something we really need to dig

into and so they say yeah absolutely I

mean after all real estate is a highly

leveraged industry and usually when

rates are stable it's actually not

terrible to have higher debt on real

estate because your payments are

predictable right and generally your

rents are predictable but right now

rates have become almost unpredictable

so anyway they hear they touch on this

working from home thing but when they

talk about working from home uh and and

they talk about this this double whammy

basically of like your loan resetting

your loan resetting is coming up to that

seven year uh refinance window right

that's your loan reset uh and then

combine that with work from home all of

a sudden you're in a very very

precarious situation compared to where

you were in 2019 now some are making the

argument that all of this is just fun so

the fud argument is look uh work a work

from home is great but offices are

needed

and because of uh e-commerce fud less

building is being done uh for offices I

mean who really wants to build uh an

office right now right so

the argument here is okay on one hand

mortgages for commercial real estate are

resetting

people might be losing a lot of their

office space as tech companies sort of

re-jigger and layoff and downsize but

because less office is being built maybe

there'll be a supply constraint and

maybe there could actually be an

opportunity in office and I always love

the counter argument I think the counter

argument is always fantastic but they

make a really good point that it's not

going to be all office and this I think

is very interesting look at this segment

here

if you're talking about New York City

return to office we're still well below

50 occupancy rates people actually using

office space are in the 30 to 50 range

now specifically about New York before

we talk about where they're positive

specifically on New York

you have a lot of office buildings in

New York that were built in the 60s

and 60s Office Buildings are not ideal

I will explain why a 60s office building

is not ideal a 60s Office Building looks

a lot like your uh very sort of uh FBI

style Square building uh let me see if I

can get you an example here you know

what I'll do exactly that I'll pull up

let's do like uh let's go mid century a

little past mid-century 1960s office

building

and uh let's see what we get here uh

yeah okay perfect so we'll go ahead and

pull these up

this is your kind of classic uh

mid-century 1960 style office building

right here where you you see these

frequently with Federal buildings they

have small windows at the outside and

then a lot of office space on the inside

let me show you why graphically that is

actually really important why I'm

describing them so if we go here

and we say we have natural light that

comes in

potentially to these Corners to sort of

the edges here of the office building

what you actually have in the middle of

the office which is where the bulk of

the square footage is the middle of the

office is actually a very dark uh and

dare I say somewhat gloomy space for a

1960s office building and you have

massive problems in New York right now

because that Central Area can't be

redeployed into two very important

things there are two very important

things you want to do with offices

number one can you make condos well no

because people want light people want a

lot of Windows people don't want to be

in the red so you've lost most of your

real estate on every floor of these old

Office Buildings for a lack of light

uh and number two do you want how about

how about new offices

oh but wait what do people want today in

a new office modern contemporary uh

co-working spaces right they want a

fiber internet these

these buildings A lot of them built

post-war in New York uh specifically

around like Third Ave and a little bit

more on the east side

they're nearly worthless

and it's really incredible but a lot of

the office space that is actually vacant

is nearly unusable so so that actually

creates a little bit of a counter

argument to this idea of uh oh well well

maybe

um uh you know maybe the office uh

segment uh will be so terrible because

well actually it could create this

double whammy where on one side you have

more defaults on buildings like this

that are unusable but at the same time

then you have a lack of inventory for

stuff that people actually need they

have this weird like banking crisis

fueled to the fire but potentially

something that actually props up the

quality office Market it's pretty

remarkable uh but let's go back over

where were we let's go back over here

and uh let's go to the uh actually let's

go here and let's go back to the story

here

so the story

is right here so if you go to the Sun

Belt in contrast

there is a lot and there are a lot of

reasons for this return to office and

the use of office space is a lot higher

than in New York

it's not surprising then to see that at

60 70 maybe even a little bit higher

than that in terms of occupancy so

there's a big

difference between how people and say

New England are using office versus

let's say Tampa or Florida or Austin and

what have you and now this is actually I

think very very important because think

about this so watch this

if work from home

uh work from home trends away that is

less work from home going forward then

where do you want to buy real estate

well how about where the new offices are

that would be ideal because where the

new offices are

uh guess what

people have to live

so that means people want to live there

because they have to be close to their

office you can't remote from home work

you can't work remotely and be in the

office I mean I know there's hybrid but

to some extent you still have to be

there so there's this big argument that

actually says the Sun Belt regions of

Texas Florida North Carolina Atlanta

Arizona

SoCal uh potentially to some degree Utah

although that's not really Sunbelt uh

these areas could potentially really

be quite desirable for real estate

investment longer term

in the short term yeah to some extent we

might see some fuel added to the banking

crisis fire

but in the longer term we might actually

see opportunities out of this and this

is where those opportunities might be

let me see if there was anything else we

wanted to note here in this story is a

little bit more uh by the way it's worth

noting that even though I'm not a big

proponent of of people using uh buy now

pay later I I really don't like it a lot

of people have been asking for it anyway

and so we provided by now pay later and

I want to give you some stats here we

provided buy now pay later for those of

you interested in joining the programs

on building your wealth link down below

and of those who signed up yesterday 50

percent

I want to say it was even slightly above

50 it might have been like 52 or

something

50 to 52 percent of of people who signed

up yesterday uh for the programs of

building your wealth lifetime access use

buy now pay later the most popular was a

firm followed by Clara I thought that

was very interesting sort of a little

insight that there there is I mean like

it or not there's there's a demand for a

product you know it's kind of like a

grocery store you could be

totally opposed

to taking vitamins you could be you know

one of the the naturalists who's like

I'm not taking vitamins right

but the reality is fifty percent of

Americans take vitamins

so are you just not going to carry

vitamins in your store so I find it very

interesting but anyway I thought you all

might appreciate that uh that Insight

all right

continuing if you were to go back to Q3

2022 not so long ago the read Market was

down more than 30 percent here today

that's the Reit stock market but believe

it or not private valuations we're still

up more than 10 percent year-to-date on

a year-to-day basis this is true that's

true go back to about June the REITs

were super discounted but that's really

potentially because they haven't taken

the private markdowns yet there's uh

what happened is the listed market so

that's publicly traded REITs is always a

leading indicator for the private Market

that's actually a fantastic way to look

at it they go down before the private

Market well that's because the stock

market is so much faster than the uh you

know private real estate market to some

extent you could say this about private

Equity as well why is it that why is

that the case well listed reads get a

mark on them every single day people buy

and sell stocks on the other hand

valuing a property can be hard if you

get appraisal etc etc yeah uh very good

point

um

this is interesting this I completely

agree with

and so I want to point this out the

first way we think about distress is

that distressed sales as a percentage of

overall transaction volumes right now

are very low very low they're very low

distress sales I just saw my first short

sale in potentially

10 years or more it was crazy I said

shorts Hill like oh my gosh it's been a

while since I've seen somebody selling a

property short that means you're selling

a property that you owe more money on

than it's worth

the stress sales are very low right now

I don't think they're going to stay low

I think they're going to increase but

the reason distressed sales are low

right now is that Banks haven't started

foreclosing on their loans and the

spread between buyers and sellers is

pretty wide distressed sales are low and

while we can talk about delinquencies

like cmbs commercial mortgage by

Securities and Bank delinquencies

distress sales are the first thing I

look at it's showing signs of ticking up

and I think it's going to arise

yeah that's that's not great to answer

your question up front it can

historically take 12 to 24 months for

private property valuations to correct

to what the listed Market is pricing

this is talking about REITs this is why

I think there's there's not as much of a

rush to buy real estate as as people

believe uh right now that's why we're

targeting Q3 Q4 for house hack

about 15 to 20 of maturing debt is

coming due each year over the next five

years this has to do again with the

commercial

with an average of 500 billion dollars

per year most of the debt coming due in

2023 uh was originated between 2013 and

2018. property prices have risen since

13 so the loan to value is lower

uh even if valuations fell 10 to 30

percent next year there's a good chance

these loans are not underwater yet this

is the case uh this is not the case for

offices or malls Mall's effective loan

to values are around 90 to 95 there's

probably a good case study for where the

office Market is going office properties

account for only about 25 percent of the

15 to 20 percent of maturing debt that's

coming due and who holds that well a lot

of it are bank balance sheets and so

this is where when Banks hold a lot of

this debt that's coming due you could

potentially be amplifying the banking

crisis as we've said and this will

ultimately pressure valuations lower and

it's not just in commercial real estate

but if there's distressed debt in

single-family real estate as well uh

then uh then you're likely to see pain

there also I personally think we're

likely to see an explosion of inventory

over the next uh probably

I would say uh six months so if I had to

give a prediction

if I had to give a prediction I would

say over the next six months you'll

probably see inventory

as much as 5x now that that sounds

incredible

because inventory is so so low right now

and we think to ourselves why would

somebody sell who doesn't need to sell

well the reason people might sell or

they're an institution they need

liquidity they're a bank and they're

foreclosing they're read and they need

to sell their a pension fund and they

need to divest their family office and

their divesting uh there are plenty of

reasons that people might sell uh it

could be a collapse and Airbnb

valuations potentially because airbnbs

maybe aren't renting as much as they

used to and then those individuals try

to go rent their properties long term

and they're frustrated they think okay

well I'll just rent the property for a

year or two until the Airbnb Market

comes back but then after they rent out

the property they realize I don't want

to be a landlord and all of a sudden

they sell that rental or worst case

scenario they leave the house vacant

there's somewhere around a a 15 a set of

15 million properties in America that

are vacant most of those are vacant

because of poor management terrible

Property Management people don't know

what they're doing in real estate

they haven't taken the zero to

millionaire real estate investing course

there's a do-it-yourself Property

Management course

but vacant real estate will decay

and eventually when that vacant real

estate hits the market it will hit the

market at depressed prices

so I believe that over the next six

months we can see inventory 5x and there

will be glorious opportunities to invest

in real estate Q3 Q4 q1 it'll be great

we'll see uh but that's my take

regarding the stress on commercial real

estate on banking I think it's a very

legitimate concern that could amplify

the banking crisis and could continue to

tighten credit standards at Banks

which has a very depressive effect on

our economy we can see consumer spend

plummet uh some say up to about 10

percent

and that's not so great for especially

the lower end consumer But ultimately

all consumers

even losing 10 percent of the higher net

worth individuals uh and and 10 of their

spending goes away now you're comparing

to higher comps and you have a little

bit more of a uh an earnings per share

fight

so it's a rough time

going forward as an individual how all

this applies is again I would make sure

I'm with well within FDIC limits and

diversified in my Banks

then I would continue to try to make as

much money as possible and I think

that's very important to work very very

hard but I would also consider when

you're investing the work from home

trend

take a look at this this is a Wall

Street Journal piece from this morning

working remotely is becoming listen to

this phrase

increasingly rare just a few years after

the pandemic caused multiple well

countless of millions of Americans to

work from home some 72.5 percent of

business establishments said their

employees teleworked rarely or not at

all last year according to the labor

department that figure climbed from 60.1

percent in 2021 and they s the survey

showed about 21 million more workers on

site full-time in 2022 compared to the

prior year

the new number is also closer to the

share of establishments 76 percent that

said they had no employees teleworking

before commit the pandemic that were

open in February 2020. employers have

recently begun pushing harder to get

staff to work on site more as recession

fears prompt increase emphasis on worker

productivity it's true the easy days are

over

now it's now it's hard work time you get

the same thing happening at uh at Apple

as you have at meta look at this

Starbucks has also asked office staff to

come in more often Walt Disney is

pushing for a four day on-site work week

it's incredible

uh Robert Half which is sort of a

recruiting and temp agency says that a

survey by global a global

a survey by the global recruitment firm

found that 92 percent of managers prefer

their teams to work on site the

hypothesis is it's still easier to build

trust in person and that those

relationships help us work more

effectively

they couldn't be more correct

this is why we have a requirement uh at

my companies to work in the office any

new hires have to be in the office have

to be on site we don't do remote work so

that's the the first thing we do with an

application is they say remote work no

thank you uh we're pretty clear about

that though

so it's also kind of uh not following

instructions when people apply anyway

but that's okay so I think it's very

interesting and to me this this is a big

deal for Real Estate you know just in

the last

golly uh month here I think I've been

across the United States I mean

countless times but uh but on somewhere

around 80 to 90 different flights and uh

I I see this this uh this this trend

towards City centers again it's it's

incredible it's almost on it's almost

Amplified right now whether it's St

Petersburg Tampa Dallas Austin uh you

name it it's pretty incredible

pretty incredible uh so but again as an

individual my thinking is

uh do whatever you can to make more

money if that means moving to an area

where you could work in person with a

business that's fantastic you should do

that curious to see where you're going

leave some comments in terms of where uh

where you're seeing people move in your

workplace uh and uh make sure you make

uh make some more money get ready to

invest in real estate there'll be some

great opportunities coming up check out

the programs on building your wealth

link down below and uh good luck to the

banks I would not want to be a bank

right now and I would not want to invest

in a bank right now given these sort of

uh stresses and losses that that are

still coming and haven't been fully

realized yet