What are the prospects for the office real estate sector and regional banks?
Financial market experts and observers are increasingly concerned this 12 months in regards to the health of the economy and, particularly, the banking sector’s dependence on the actual estate sector. The collapse of Silicon Valley Bank (SVB) and Signature Bank this 12 months, in addition to the hasty takeover of First Republic Bank, have convinced some market participants that regional banks already under financial strain may now face a possible crisis shaky industrial real estate sector. The biggest concern is the banking sector’s dependence on the office sector.
Andrews opened his discussion with Kalsi with the query of systemic risk: “Given that many banks hold large real estate portfolios, what do you think is the bottom line, particularly from both a systemic risk perspective and a banking perspective?” he asked.
Many major banks have withdrawn from real estate lending and, particularly, their lending to industrial properties has declined in percentage terms, Kalsi said. But the non-banking sector has stepped in to fill the lending gap. “Non-bank lenders often receive repo financing from the same major banks. Regional banks now provide a large amount of real estate lending and probably account for at least a third of total real estate lending and have been a large part of incremental real estate lending over the last five years,” he explained. “So I think the long answer to your question is: the regional banks are pretty heavily involved there.”
The two big issues to think about, Kalsi said, are liquidity and the condition of office properties. “There are no financing options. The big banks don’t offer it, and now the regional banks don’t offer it anymore.”
Since industrial real estate is a big category, Kalsi believes there are parts of it that shall be less problematic. He cited the economic and multifamily sectors as examples. Multifamily housing can also be supported through government-sponsored agencies that provide financing, he said. The office sector is a headache, he warned. “It’s not really the canary in the coal mine,” he said. “It’s the 800-pound gorilla sitting in the middle of the room!”
Challenge of regional banks
“So what are the regional banks going to do? “Are we just sitting on another time bomb?” Andrews asked.
“Yes, “I think it could be a time bomb,” Kalsi said, “but I think it will be a time bomb with a long fuse.” As against a security, which is a short-term instrument that rolls over within the capital markets Many bank loans are structured in such a way that the banks themselves need to pull the trigger to cause a default. “So there are a lot of assets that are technically in default right now,” he said. “It may be that different contract terms, terms, defaults, etc. are not being met and that many banks are simply extending them because they know that their borrowers are in an illiquid market and are unable to refinance them. ”
The regulatory authorities subsequently have a serious influence on whether and when the usual time bomb goes off, Kalsi assured. “On the one hand, you could argue that [regulators] “It’s because of the interest rate environment, right?” he said. “A lot of people were caught off guard. I didn’t think interest rates would rise at that rate, but we knew interest rates would rise. So I’m a little surprised that some of these lenders were caught off guard. It will be interesting to see how regulators deal with this.”
If regulators force lenders to market their positions, the result might be something ugly, Kalsi warned. “But if the regulators make it easy for them and give them time, then I think it will be a slow process.”
The most distressed sectors
“I joked that office has replaced retail as the worst six-letter word in real estate,” Kalsi said. By way of comparison, he noted that ten years ago it was retail that was facing an “apocalypse.” “Nobody shopped in stores anymore,” he said, and although retail property values have fallen 30% to 50% within the last 10 years and lots of tenants have gone bankrupt, the surviving retail tenants face less competition and so there’s a We now give you a greater business environment. “So retail has gotten some traction and is doing well,” he said.
“I think this will also happen in the office sector. But remember I said 10 years. The office sector will take a while to gain traction. So we have to decide to be patient to get through this and regulators have to decide whether they want to be patient or not,” Kalsi said.
So if regulators are patient, won’t we face one other major systemic risk event?
“I hope we will not face systemic risk again,” Kalsi replied. “I won’t name names, but there are certain lenders whose accounting is 30 to 40 percent commercial real estate,” he said. He said those banks are struggling, pointing to the bankruptcies at SVB, First Republic and Signature Bank this 12 months as examples of the forms of bankruptcies that might be coming. “I am not a banking expert. But if I were a betting man – and I am – I don’t think we’re done with three banks. I think we’ll see more.”
“Some of them own assets directly, others probably own them indirectly, whether through the REIT market or through fund managers. I think one thing you have to ask yourself is, “Do I have the right people running the ship for me right now?” I feel that’s a part of it. So that’s primary,” Kalsi said.
Number two is how one can think in regards to the asset class. “We talk about defense. We talk about what we do with our existing portfolio. How do we think about this and how do we cope with it? One thing we’re hearing a lot about these days is the denominator effect – the stock market is down, so alternatives are now a larger percentage of most of these people’s portfolios. Is that a bad thing? And maybe that’s the direction people should go here. One thing about the global financial crisis that was clearly telling is that the people who had more time ended up with a better recovery than the people who had to do a forced sale.”
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