Banks Face Billions in Losses as CRE Market Sours

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Banks face billions in losses as CRE market sours, stronger growth outlook for 2023, but headwinds loom, suburban rent growth outpaces urban areas as pandemic migration trends persist, healthcare, office merger terminated amid shareholder opposition.

📈 Market Update

🏦 Banks Face Billions in Losses as CRE Market Sours

Banks have substantially increased their exposure to CRE over the past decade through direct lending as well as indirect exposure like lending to non-bank lenders and investing in commercial mortgage-backed securities (CMBS). This has coincided with a boom in CRE, but now valuations are falling rapidly as interest rates rise, vacancies increase, and refinancing becomes more difficult. Banks are facing potentially huge losses on real estate loans and related assets totaling $3.6T. Even more concerning, the seizing up of lending from banks to real estate companies threatens to create a vicious cycle of falling property prices and additional bank losses.

Credit Crunch:
With hundreds of billions in commercial real estate debt maturing over the next two years, many developers are scrambling to refinance at much higher interest rates or are simply defaulting. Regional and community banks were very active lenders during the boom years, but are now reducing their exposure over worries about deposit outflows and losses. Developers say it is increasingly difficult to find banks willing and able to refinance matured debt. The refinancing crisis along with outright defaults on loans is depressing property valuations further.

Other Lenders At Risk:
The potential losses are not limited to banks, bridge lenders face substantial risk as well. Arbor Realty Trust has become one of the largest lenders to multifamily investors, specializing in short-term, floating-rate “bridge” loans that carry significant risk as interest rates rise. Arbor bundles many of these loans into collateralized loan obligations (CLOs) and sells them to investors. But with its own large portfolio of bridge loans, Arbor is seeing its delinquency rate skyrocket as borrowers struggle to pay in the higher rate environment. This raises concerns about future losses for Arbor itself as well as investors in its CLOs.

📈 Stronger Growth Outlook for 2023, But Headwinds Loom

The US economy has rebounded stronger than expected in recent months, prompting forecasters to sharply upgrade projections for GDP growth in 2023. Robust consumer spending, residential investment, and other positive data suggest the Fed will likely double its own GDP growth projection for next year when it releases updated forecasts this month. However, most economists still believe growth will slow in Q4 due to headwinds like higher gas prices, resumed student loan payments, and the cumulative impact of aggressive Fed rate hikes.

🏘️ Suburban Rent Growth Outpaces Urban Areas as Pandemic Migration Trends Persist

Many households that relocated from urban apartments to suburban rentals early in the pandemic have remained there as high home prices and mortgage rates prevent purchases. This is fueling the fastest rent growth in suburban areas, with suburban rents up 26% since early 2020 compared to 18% in urban cores, per Apartment List data. Despite slowing overall, rents continue increasing in many suburbs while decreasing in nearby cities. The trend highlights a longer-term shift favoring suburban multifamily properties. But new supply may eventually dampen suburban rent growth, while select urban areas like Tampa and New York City are exceptions with rents rising faster than their surrounding suburbs.

🏥 Healthcare, Office Merger Terminated Amid Shareholder Opposition

Diversified Healthcare Trust and Office Properties Income Trust have mutually agreed to terminate their planned merger that faced significant shareholder opposition. The failed deal leaves Diversified Healthcare needing to address $700M of debt coming due by 2024 that it had warned it likely could not fully refinance on its own. Diversified Healthcare will now have to pursue alternative options like targeted asset sales, while top shareholder Flat Footed argued the debt is supported by over $1B in collateral and can be "easily addressed." The termination comes after proxy advisors and investors argued the merger terms were unfavorable for Diversified Healthcare.

✍️ Further Reading

• KKR’s McVey Boosts Economic Outlook, Recommends Investors Buy Real Assets (BBG)

• Blackstone’s Private Credit Fund for the Rich Lands $2.4 Billion (BBG)

• Torchlight Grabs Fifth Avenue Retail Property From Harbor Group (RD)

• Dallas Buyer Eyes Housing in Suburban Los Angeles Mall Redevelopment (CS)

• Soho House Wants to Crack America — and Not Just New York (BBG)

• Expenses for Apartment Owners Continue to Outpace Rents (GS)

• Renting Remains Most Affordable Option for South Floridians (CS)

📊 Chart of The Day