A version of this story first appeared in CNN Business’ Before the Bell newsletter. Not a subscriber? You can sign up right here. You can listen to an audio version of the newsletter by clicking the same link.

Economists are growing concerned about the $20 trillion commercial real estate (CRE) industry.

After decades of thriving growth bolstered by low interest rates and easy credit, commercial real estate has hit a wall.

Office and retail property valuations have been falling since the pandemic brought about lower occupancy rates and changes in where people work and how they shop. The Fed’s efforts to fight inflation by raising interest rates have also hurt the credit-dependent industry.

Recent banking stress will likely add to those woes. Lending to commercial real estate developers and managers largely comes from small and mid-sized banks, where the pressure on liquidity has been most severe. About 80% of all bank loans for commercial properties come from regional banks, according to Goldman Sachs economists.

“I do think you will see banks pull back on commercial real estate commitments more rapidly in a world [where] they’re more focused on liquidity,” wrote Goldman Sachs Research’s Richard Ramsden in a note on Friday. “And I do think that is going to be something that will be important to watch over the coming months and quarters.”

Recently, short-sellers have stepped up their bets against commercial landlords, indicating that they think the market will continue to fall as regional banks limit access to credit. Real estate is the most shorted industry globally and the third most in the United States, according to S&P Global.

So just how big of a deal is this threat to the economy? Before the Bell spoke with Xander Snyder, senior commercial real estate economist at First American, to find out.

This interview has been edited for clarity and length.

Before the Bell: Why should retail investors pay attention to what’s going on in commercial real estate right now?

Xander Snyder: Banks have a lot of exposure to commercial real estate. That impacts banking stability. So the health of the market has an impact on the larger economy, even if you’re not interested in commercial real estate for commercial real estate’s sake.

How bad are things right now?

Price growth is slowing and for some asset classes it’s starting to decline. Office properties have been more challenged than others for obvious reasons.

Now private lending to the industry is starting to slow as well — bank lending was beginning to dry up over a month before the Silicon Valley Bank failure even happened. Credit was getting scarce for all commercial real estate and a fresh bank failure on top of that only exacerbates that trend.

How do you expect banking turmoil to make things worse?

I think more regulatory scrutiny is coming for smaller banks, which tend to have a larger concentration of commercial real estate loans. That means small and medium-sized banks are going to tighten lending standards even more, making it more difficult to get loans.

Does the possibility of a looming recession play into this?

As credit becomes scarcer and more expensive, it’s hard to know exactly what buildings are worth. You get this gap opening up between sellers and buyers: Sellers want to get late 2021 prices and buyers are saying ‘we don’t know what things are worth so we’ll give you this lowball offer.’ That was already happening and the result of that price differential was bringing deal activity down.

There’s no broad agreement on asset valuations. Economic uncertainty will exacerbate that trend. And if you’re a bank, it’s a lot more difficult to lend against the value of a building if you don’t know what the value of the building really is.

So how worried should we be?

A lot of people hear commercial real estate and they think it’s all the same thing and the trends are they’re all the same but they’re not. The underlying fundamentals of multifamily and industrial assets remain relatively stable on a national level.

It’s different for office and retail properties. There’s been a fundamental shift in how we use office space and that has changed demand. That’s something you should have your eye on, especially as low-interest office loans come due. We’re running into a situation where office-owners have to refinance at a higher rate and only 50% of the building is being used. That doesn’t translate to good cash flow metrics for the lender.

I think retail also faces challenges. A lot of people are still sitting on excess pandemic savings that are beginning to be spent down and the Fed is certainly trying to nudge unemployment up a little bit. So I imagine that both of those things will impact retail spending and therefore impact retail as an asset class.

Economists forecast recession and elevated inflation

Stagflation, the combination of high inflation and a weakening economy, could make a comeback. The majority of economists expect a recession sometime this year and forecast that inflation will remain above 4%, according to The National Association for Business Economics’ latest survey, released Monday.

It appears as though the fog has lifted since last month’s survey, which showed a significant divergence among respondents about where they think the US economy is heading in 2023.

“Panelists generally agree on the outlook for inflation and the consequences of rate hikes from the Federal Reserve,” said NABE Policy Survey Chair Mervin Jebaraj. “More than seven in ten panelists believe that growth in the consumer price index (CPI) will remain above 4% through the end of 2023, and more than two-thirds are not confident that the Fed will be able to bring inflation down to its 2% goal within the next two years without inducing a recession.”

Still, more than half of NABE Policy Survey panelists expect a recession at some point in 2023. But only 5% believe the United States is currently in one. That’s nearly four times lower than the 19% who believed the US was in a recession in August. 

Banking turmoil brings us ‘closer right now’ to recession: Fed President Kashkari

The recent meltdown in the banking industry could tip the US into recession said Federal Reserve Bank of Minneapolis President Neel Kashkari.

“It definitely brings us closer right now,” he said during a CBS Face the Nation interview this weekend. 

“What’s unclear for us is how much of these banking stresses are leading to a widespread credit crunch. And then that credit crunch, just as you said, would then slow down the economy,” he added.

While Kashkari said that the financial system is “resilient” and “strong” he said that there are still “fundamental issues, regulatory issues facing our banking system.”

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The availability of apartments and units that can be rented is staggeringly low. Because vacancy is so tight, competition in the open market has intensified, lifting rental prices along the way. In Canada, rent for a two-bedroom unit rose 5.6% in 2022. Some of the highest rental prices were recorded in Ottawa-Gatineau at 9.1%, Toronto at 6.5%, and Calgary at 6%.

Less housing stocks, higher prices. The marketplace and our elected officials all knew this would happen. Real Estate Agencies and land developers all but jumped for joy at the prospect of selling homes that sold for $350,000 a few years ago, and are now selling for 3X the amount. Bidding wars drive prices higher and higher. Developers who make a home at @$195,000 cost sell these homes as affordable within the 650-1M range.

So much for independent home units. What about apartment buildings? Are they being built? In Quebec they are but not in the # needed. Europeans are comfortable with renting an apartment for decades, but not so in the rest of Canada. Status, and keeping up with the “joneses” have been all the rage. First-time home buyers will spend decades gathering enough funds to make an initial deposit if the bank so allows it. Why do developers not build rental units/apartments? Well, developers would need to look upon such builds as long-term investments, waiting some time to get back their costs and make some profit. Building other types of homes guarantee them immediate compensation, gratifying their profiteering.

Why do regional, City, and Provincial Governments prefer housing builds of larger houses? The revenue they make of course. Even Premier Ford’s push to have 50,000 houses built in a few years centers upon individual homes being sold, not rented(aftermarket). Has our economic system forgotten the small fry, the average Canadian who does not make a salary over $100,000 annually? Yes, it has, and the reason for this forgetfulness is that the wealthy and mid-level middle class hold greater influence on these elected officials. They are the same people, while the dirty unwashed working stiff has very little in common with real estate agents, developers, and elected officials too. A true class system with regard to housing exists in Ontario and Canada. Are the New Democrats crying out loud for reforming this system? No, they are not. They want to represent the higher-ups. those with excess revenue and economic purchasing power.

Rental Units are Needed Stupids. A housing revolution is needed not just in Ontario but across this land. Why won’t the government put its hands into the direct building of these units? They have the funds, and the regulations to make sure these units are made appropriately and in a timely manner. The very power of the elite, real estate, and developers lobby will always sway our elected officials away from competing with these financial aggressors. In 2016 548 formers members of a government in Canada registered as lobbyists, often representing the wishes of those who once were their suppliers(developers). What am I saying? Perhaps many of our elected representatives have been padding their pocketbooks and ensuring their future careers in well-paid jobs. Corruption? Find out how much an MPP or MP was worth when they started their position, and after 4-5 years what are they worth???

Only the average Canadian, worker, student, or elderly who cares about their children’s future, can force this issue before the politicians in Ottawa, Toronto, and through out Canada. Protests like those that happened in Ottawa last spring could really change the way our representatives represent us. A wee Revolution we need indeed.

Housing and shelter are human rights. Right? So get off your couch and gather with like-minded neighbors to demand real affordable housing, and build nonprofit apartments too.

Steven Kaszab
Bradford, Ontario
skaszab@yahoo.ca

Mortgage rates are still falling as the Fed announced another quarter-point rate hike on Wednesday — and indicated increases may be nearing their long-awaited end.

In the meanwhile, the homebuyer front is seeing “improved purchase demand and stabilizing home prices,” says Freddie Mac chief economist Sam Khater.

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“If mortgage rates continue to slide over the next few weeks, look for a continued rebound during the first weeks of the spring homebuying season.”

Khater and other experts are anticipating more buyers will return to the market as rates become more affordable. However, that doesn’t mean housing prices are going to subside anytime soon.

30-year fixed-rate mortgages

The average 30-year fixed rate slid further to 6.42% this week, compared to last week’s average of 6.60%.

A year ago at this time, a 30-year home loan averaged 4.42%.

“With rates below 6.5%, more Americans can purchase the median-price home by putting 18% down without being cost-burdened,” says Nadia Evangelou, senior economist for the National Association of Realtors (NAR).

Evangelou anticipates the housing market to rebound even faster than expected if mortgage rates continue their decline this spring.

15-year fixed-rate mortgage rate trend

The average rate on a 15-year home loan tumbled from 5.90% to 5.68% this week. This time a year ago, the 15-year fixed-rate averaged 3.63%.

Hannah Jones, economic research analyst at Realtor.com, notes that despite the Fed’s softened stance on additional rate hikes, the federal funds rate will still remain fairly high — “meaning that a higher interest rate environment is here to stay for the time being, including for home loans.”

Jones says that while buyer demand is increasing due to slightly lower financing costs, many Americans are still grappling with affordability challenges.

“At the current price and mortgage rate level, the typical housing payment on a median-priced home is still 36.4% higher than one year ago.”

U.S. home sales pick up in February

There was an unexpected uptick in new home sales in February, inching 1.1% from January to an annual pace of 640,000 new home sales, reports Realtor.com. This is still 19% lower compared to the housing market a year ago, but sales may continue to rise as mortgage rates fall.

“Higher mortgage rates are the new normal, which leaves home shoppers measuring their willingness to participate in the market with each change in rates,” writes Jones.

She adds that sales activity is becoming increasingly concentrated toward new homes that haven’t been started yet — making up about 23% of new home sales in February, compared to 17% in January — suggesting that “buyers are looking to lock in a good deal now, before construction has started.”

Although lower mortgage rates signal increased affordability, the median new home sale price climbed to $438,200 last month — 2.5% higher than the same period last year.

“As long as the housing market remains undersupplied, buyer competition will put upward pressure on prices,” explains Jones.

Mortgage applications continue to rise

Demand for mortgages rose 3% from last week, according to the Mortgage Bankers Association (MBA).

Homeowners have also been more encouraged to refinance — thanks to lower rates — with the refinance index climbing 5% since the week prior.

“Both purchase and refinance applications increased for the third week in a row as borrowers took the opportunity to act, even though overall application volume remains at relatively low levels,” says Joel Kan, vice president and deputy chief economist at the MBA.

Kan notes that mortgage rates haven’t plunged as drastically as Treasury rates due to increased volatility in the mortgage-backed securities market.

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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.

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