U.S. commercial real estate is facing its worst. As people's working patterns changed due to the COVID-19 pandemic and interest burden increased due to high interest rates, offices that investors once 'couldn't buy because they didn't have any' became a nuisance and were even converted into apartments. One year after the U.S. Silicon Valley Bank (SVB) declared early bankruptcy, some say that commercial real estate will be the detonator of a crisis in the U.S. financial sector that may become a reality again in the future.
The collapse in commercial real estate prices is a phenomenon that has occurred in the past. However, most experts believe that this phenomenon is not a temporary cause but is triggered by structural changes such as work methods, so it will not be easily resolved except by lowering interest rates. Nevertheless, on the one hand, global asset management companies that are willing to actively invest in commercial real estate are emerging, and even the U.S. Federal Reserve (Fed) considers it a problem that can be dealt with, and the temperature difference among experts is mixed.
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| High-rise buildings in Manhattan, New York. AP Union |
“Record-high vacancy rate, expected to continue to rise.”
According to Moody's Analytics, the U.S. office vacancy rate, which was 12.1% at the end of 2019, hit 19.6% in the fourth quarter of 2023. In the first quarter of this year, it rose further to 19.8%. This figure broke the highest quarterly vacancy rate of 19.3% over the past 40 years. Large cities such as New York, San Francisco, and Atlanta exceeded 20%. The industry predicts that it will soar to 19.8% by the end of 2024. As of 2022, the office market value was found to have decreased by $664.1 billion (approximately KRW 892 trillion) compared to 2019 before the pandemic began.
The biggest reason for the downturn in the U.S. commercial real estate market is that the work patterns of U.S. workers have become more diverse, including working from home, due to the pandemic. Demand has decreased, but the offices that were built in droves in the 1980s and 1990s have nowhere to go. As a result, major cities are experiencing tax revenue shortfalls and there are even rumors of tax increases. Aaron Peskin, chairman of the San Francisco City Council, predicted, “The city could experience a fiscal deficit of $1 billion (approximately KRW 1.3433 trillion) over the next few years due to a lack of tax revenue due to the commercial real estate downturn.”
Offices that have become 'zombie towers' due to people leaving are attempting to transform into apartments to preserve their value. According to Rent Cafe, a U.S. real estate research agency, as of January 2024, more than 55,300 offices have already applied for a change of use to housing, which is more than four times more than the survey conducted at the same time in 2021, three years ago.
But even this is not an easy task. Offices are often located in areas that people do not normally think of as residential areas, and have structural problems such as windows that do not open or interior design that is different from the residential type. CNN Business emphasized that it is not easy to convert only 3% of New York and 2% of Denver buildings into residential buildings.
“Small and regional banks take on 70% of commercial real estate loans
The real problem is not yet visible. According to the 'March 2024 Monetary and Credit Policy Report' announced by the Bank of Korea on March 14, the maturity of U.S. commercial real estate (CRE)-related debt this year amounts to $544 billion (approximately KRW 730.7552 trillion). In a situation where both interest rates and vacancy rates are high, banks have to repay all at once or refinance at much higher interest rates, but there is no way the financial sector will easily grant loans after seeing SVB's bankruptcy and Signature Bank's collapse in 2023. If the loan is not secured, the office must be placed on the market to repay, but Wall Street estimates that the number of CRE cases in which the asset value is far below the loan size will reach double digits (percentage).
According to Morgan Stanley, about 70% of the $1 trillion (approximately 1,343 trillion won) worth of CRE loans maturing by 2025 are held by small and medium-sized and regional banks. Among U.S. banks, the proportion of CRE loans for banks with assets of more than $100 billion is around 12.8%. On the other hand, for banks with assets of less than $100 billion, the proportion is around 35%. Non-performing loans are already on the rise. As the Federal Reserve's tightening policy continues after 2022, the delinquency rate of banks' CRE loans has already risen, with the delinquency rate of these loans rising from 0.64% in the third quarter of 2022 to 1.07% in the third quarter of 2023.
In fact, the New York Community Bancorp (NYCB) incident in January 2024 raised the market's sense of caution. This is because NYCB, a mid-sized bank with over $100 billion in assets, recorded unexpected losses in its fourth quarter results released at the end of January due to large loan loss reserves in preparation for non-performing CRE loans. NYCB managed to put out the urgent fire by attracting $1 billion in investment on February 6 (local time), but the market even brought up a scenario of a series of bankruptcies and banking crises among small and medium-sized banks.
The downturn in U.S. commercial real estate is returning as a boomerang to investors who believed in overseas real estate. In Korea, there are various products such as American real estate investment trusts and public offering funds, but the returns are not all high, so many investors are troubled. For example, investors in Mirae Asset Maps American Real Estate Investment Trust No. 9-2 (MAPS No. 9-2), which suffered losses when the maturity date returned on February 21, are even talking about filing a lawsuit against the seller, Mirae Asset Securities, claiming that they did not receive a proper explanation of the product structure. there is.
Negative outlooks from the world's three largest credit rating agencies continue. According to Business Insider on March 21, Fitch said, “Office real estate values have fallen 35% so far this cycle,” adding, “The value is still higher than the 47% decline during the financial crisis, but looking at recent developments, the decline is expected to slow. “I can’t see it,” he diagnosed. On March 27, S&P ultimately downgraded the credit rating outlook for five U.S. regional banks due to concerns about CRE insolvency, and Moody's assessed that commercial real estate concerns are still not improving.
Nevertheless, dinosaurs are investing in offices
Despite this, some investment groups do not hide their view that the U.S. commercial real estate market has reached its bottom. Global investment bank (IB) Goldman Sachs and asset management company Schroeder recently expressed their intention to invest in U.S. commercial real estate. Jim Garman, global head and partner of Goldman Sachs' real estate investment division, said on March 13 that the U.S. CRE market would recover slowly, but announced the resumption of active investment, saying, "Now is an opportunity to buy again."
The reason the investment community made this decision was due to positive signals from Federal Reserve Chairman Jerome Powell regarding interest rate cuts. Chairman Powell said at a hearing of the Senate Banking, Housing, and Urban Affairs Committee on March 7, “I think that if there is progress in lowering inflation, we can and will begin the process (lowering interest rates),” and “The Fed will keep inflation at 2%.” We are waiting until we are confident that it is falling sustainably. “Not far from it, we will relax regulations when we have that confidence,” he said. As Chairman Powell said, if high interest rates, one of the main causes of the office crisis, are resolved, there is a greater possibility that a green light will be given to commercial real estate issues.
However, apart from the banking crisis, it was also diagnosed that the growth potential of the global economy has slowed significantly in recent years. The World Bank (WB) said in its report titled ‘Falling Long-Term Growth Outlook’ on March 27, “If we do not increase labor supply and investment and increase productivity, a ‘lost decade’ will occur globally, not in specific regions or countries.” He warned.