Commercial Real Estate

This is a topic I have been wondering about and the potential impact on the greater economy and Bank Balance Sheets in particular.

This Bloomberg podcast caught my attention. It is short on deep detail but does provide a high level overview.

1. Only US market addressed here.
2. Market size US $ 20 Trillion +/-.
3. Top level components
   
   1. Office Space.
   2. Residential units.
   3. Shopping Malls.
4. Geographic coverage –
   
   1. NE primarily Manhattan
   2. Sunshine belt – mainly Florida
   3. SW mainly Texas, Austin, Dallas, Houston
      

Main takeaways

LTV (Loan to Value)

CRE generally exhibits low LTV of 30% on average with pockets of higher risk.

Holders of CRE

A high proportion of CRE is held on Bank balance sheets. Other owners:

• Banks
• bundled products (REIT) sold to investors’.
• private investors.
  

Conclusion

There is no immediate concern or systemic risotto banks at the moment.

—

Bloomberg Odd Lots Podcast – Commercial Real Estate Market

Markets are suddenly on edge due to strains in the financial system. But banks aren’t the only source of stress. Pockets of the commercial real estate market — which is worth around $20 trillion — are showing cracks as well. Higher interest rates are one factor, but also a lot of commercial office space is still not at pre-Covid capacity levels, putting pressure on income. So where are the trouble spots? And who is holding the bag? On this episode of the podcast, we speak with Rich Hill, head of real estate strategy & research at Cohen & Steers, about the state of the market.

Rich Hill, head of real estate strategy & research at Cohen & Steers

REITs have historically made solid returns following the onset of a recession, particularly in the early stages of the cycle, making this an ideal time for investors to begin building an exposure to the asset class, says Rich Hill, head of real estate strategy and research at Cohen & Steers.

Speaking on the Nareit REIT Report, Hill said REITs have historically produced average 12-month forward returns of more than 10% following the onset of a recession, with early-cycle returns exceeding 20%.

fundamentals are on a solid footing, especially for REITs. “We do expect deceleration in growth as the broader economy slows, but our expectation is for REIT fundamentals to perform better than what typically occurs during recessionary periods.”

A key reason for this is favorable supply versus demand dynamics. “Everyone talks about inflation being a bad thing, but in this case, inflation’s maybe actually a good thing because it’s limiting supply. It’s difficult to build new buildings given high construction costs, high labor costs, and high financing costs,” he said. Hill added that he expects a much better outlook for inflation in 2023.

Meanwhile, Hill said the discrepancy in valuations between private and listed real estate is unlikely to persist in 2023. Cohen & Steers expects private valuations may be down 10% to 20% in the year ahead.

“We think adding a 10% to 20% allocation of listed real estate to a portfolio of private real estate can simultaneously reduce volatility and increase returns. We probably favor being a little bit more overweight listed right now, given the supportive backdrop,” Hill said.

Hill also noted that if the financing markets stabilize or even improve, and fundamentals remain solid, there is potential for M&A activity later in 2023. Overall though, transaction volumes are down, distress is still low, and there’s a lot of money on the sidelines. “We’re sort of in a wait and see discovery process right now,” he said.