Stay informed with free updates
Just sign up to Real estate sector myFT Digest: delivered straight to your inbox.
That plucky – slightly boring – Canadian insurance company known as Manulife doesn’t often get attention. This week, however, caused a stir in the real estate world.
Shortly before Jay Powell, chairman of the Federal Reserve, announced that the central bank would keep key rates between 5.25% and 5.5%, Colin Simpson, chief financial officer of Manulife, revealed that the group had devalued the value of its US office investments is up 40% from its pre-Covid peak.
“I like to think that our real estate portfolio is reasonably high quality and fairly resilient,” Simpson told Bloomberg. “But structural forces of higher interest rates and return-to-office trends make this a challenging market.” Simply put: working from home is bad.
At first glance, it seems scary; 40% is a big number. But investors should actually celebrate. Good news is that Manulife has relatively deep pockets and therefore can absorb this hit. The second, more important point is that Manulife’s move shows that some players are finally becoming more honest about the woes of America’s commercial real estate sector.
This is welcome – and overdue. As hopes for U.S. rate cuts have intensified in recent months, CRE has fallen into a debilitating pattern of “extend and pretend”: lenders have essentially rolled over troubled loans, hoping for a future miraculous Fed bailout.
However, Wednesday’s Fed meeting made a key point: Powell’s priority now is not to protect CRE, but to keep inflation in check at a time when consumer activity remains surprisingly buoyant and inflation is rising. moves sideways around 3%. So the trillion-dollar question is: How many other players will now follow Manulife’s lead – and finally deal with one of the biggest cheap-money-fest hangovers of the past decade?
The answer matters because the financial system is currently plagued by a teetering pile of low-cost CRE loans. Research conducted last year by Newmark suggests that more than half of this came from banks; regional banks were especially frenzied lenders as the Fed made money almost for free during Covid-19.
However, funding also came from private lenders and the commercial mortgage-backed securities industry, often bundled into collateralized loan obligations.
Post-Covid, however, CRE values have fallen by an average of 33%, and in some places by up to 60%, mostly for office buildings, according to Goldman Sachs. And while demand for high-quality properties remains high, the outlook for low-quality buildings is bleak.
Flashes of distress are appearing across capital markets as an increase in defaults among CLOs emerged this week. Some banks are under stress, too: New York Community Bank was recently forced into a $1 billion emergency capital raise due to CRE losses, and this week the Klaros Group warned that more than 250 small banks on 4,500 existing banks in the United States are also under stress. vulnerable.
But what is striking is not that some critical points have emerged, but how little pain has been crystallized so far. This is partly because capital market lenders are rolling over bad debt: Newmark recently told clients that “of an estimated $163 billion with CMBS maturities in 2023 (based on original maturity date) , $83.3 billion remains outstanding” – meaning borrowers have exercised “extension options.” ”.
But even banks are proving tolerant: Goldman Sachs estimates that $270 billion in commercial mortgages, which were due to expire in 2023, have been extended until 2024. As a result, a record amount of low-cost loans are expected to expire this year. year. Newmark estimates there is now about $1.3 trillion in distressed CRE debt, of which $670 billion will mature over the next two years.
About a third of this debt was originated when rates were at their lowest during the pandemic, he adds. So even if the Fed cuts rates this summer, as Powell indicated Wednesday, these borrowers will face a refinancing shock: The median projection from Fed governors is that rates “will be 4.6% at the end this year, to 3.9% at the end of this year.” end of 2025, and 3.1 percent at the end of 2026.”
So what happens next? A repeat of 2008 seems unlikely: the banking system as a whole is quite well capitalized and after the collapse of Silicon Valley Bank last year, the Fed rushed to create systems to contain the contagion. Thus, while the 2008 shock was about the pain of lenders and borrowers, today’s crisis is primarily about creditors.
But the problem is that as long as these “fake and extend” tactics continue, uncertainty will haunt the real estate sector, threatening to undermine American growth. What needs to happen now, in other words, is not just for lenders to become more transparent about their losses and write them down – as Manulife has done – but for distressed properties to start trading too. Only then can the excesses of the pandemic era be resolved by demolishing unwanted buildings or repurposing them.
In this sense, therefore, the fact that the Fed remained idle on Wednesday is good news; indeed, for my taste, it would be better to remain aggressive for longer. Investors need to get used to a world where money is priced more normally, where it is not always possible to bet on a Fed put. If – or when – this happens with real estate, we will know that market distortions last decade are finally coming to an end.
gillian.tett@ft.com