The End Of "Extend And Pretend"

Authored by Daouglas French via The Mises Institute,

The number of U.S. commercial foreclosures spiked to 635 in January 2024 from a low of 141 in May 2020 reports real estate data firm ATTOM. The January count was up 17% from the previous month and roughly twice as many as in January 2023. 

“Commercial property deals in the US are picking back up at deep discounts—and forcing lenders to face just how far real estate prices have fallen,” notes Sarah Holder on Bloomberg’s “Big Take” podcast.

Bloomberg commercial real estate reporter Natalie Wong detailed a New York office building at 1740 Broadway purchased and renovated by Blackstone at considerable cost and the company has walked away with the debt that's behind that building being marketed at a 50% discount. 

Ms. Wong said,

So you're seeing these massive discounts on these prominent buildings start to show up in the market, and it's a lot harder for, whether it's the investor or the lender, to tell the regulators that the value of a lot of their buildings haven't fallen greatly. And I—so I think this is starting to create more pressure. You know, a little bit of panic, too, from parts of, you know, the, the lenders that hold these loans. 

Pretending has become much harder. 

Problem real estate means problem banks. Bloomberg reporter Patrick Clark chimed in “we certainly hear people say over the next couple of years with commercial real estate debt as a catalyst, hundreds, if not thousands of banks are gonna go away, either because they go outta business or they need to be swallowed up or they need to join forces with another weak bank to survive.” (the combination of two weak banks does not make a strong on)

Real estate mogul Barry Sternlicht told Bloomberg “there’s a giant skeleton in the closet of the regional banks,” referring to commercial real estate loans. He made the point that “every piece of real estate is worth less when interest rates go up 500 basis points.”

Sternlicht stressed that there are no lenders for buyers who want to buy properties at deep discounts.

“Commercial banks are already nervous about their commercial office exposure,” he said. 

For some banks multifamily loans are the problem. Wolf Richter reports that 49 relatively small banks which average $1.3 billion in assets “had multifamily nonperforming loans (NPLs) that exceeded 5% of their total multifamily loans. At those 49 banks, the multifamily NPL ratio of 5% is far higher than the default rate [1.9%] of multifamily CMBS.”

CREDiQ reports commercial property distress is now 480% higher than in February last year.

“We are in a period of peak stress and expect the next two quarters to be challenging,” Arbor Chairman Ivan Kaufman told analysts on a call last week, reports Bloomberg.

The firm has “longstanding relationships with many quality sponsors that we’ve been working with to step in and take over assets that are underperforming and assume our debt and recap these transactions.”

Fitch Ratings doesn’t believe we are anywhere near peak stress. 

“We expect any deterioration to play out for the banking sector over an extended period,” Fitch said.

“During the Global Financial Crisis, losses did not peak until almost two years after a peak in delinquencies, and problem loans have yet to peak for the sector.”

Extend and pretend may be coming to an end.