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Interview, Other

Commercial real estate risks

Goldman SachsScott Rechler, Stijn Van Nieuwerburgh, Alison Nathan, Sten van Nuremberg
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Commercial Real Estate Market Dynamics

  • Macro Drivers: The sector faces stress from a regime change in interest rates (moving from near-zero to normalized levels) and post-March regional banking crisis caution.
  • Structural Shift: The office sector is hit by a permanent hybrid work model (3–5 days in office) combined with cyclical refinancing pressures.
  • Multifamily Overhang: Approximately 1 million new multifamily units are under development, expected to suppress rents for several years.
  • Valuation Recalibration: Assets purchased in the low-rate era require revaluation and recapitalization as loans come due; many are currently over-levered.

Divergent Outlooks on the Office Sector

  • RXR (Scott Reckler) View: Sentiment is worse than reality; stress is bifurcated rather than universal.
    • Class A, high-quality buildings near transit retain strong tenant demand (e.g., law firms, media).
    • Analogy: Similar to the retail mall evolution where experiential locations thrived while obsolete ones failed.
    • Outlook: A slow, multi-year process of revaluation and deleveraging akin to the early 1990s Savings & Loan crisis.
  • Columbia Business School (Sten van Nieuwerberg) View: Even trophy assets are vulnerable; the decline is structural and severe.
    • Lease Renewals: Only ~33% of pre-pandemic leases have renewed; 67% remain outstanding but face high risk of non-renewal in the next three years.
    • Occupancy Data: Turnstile data shows ~50% occupancy vs. pre-pandemic; sensor data indicates ~30% usage (down from 60%).
    • Value Decline: Office stock is valued 40–45% below pre-COVID levels.
      • Top 10–15% (Class A+) lose ~20% in value.
      • Remaining classes (A-, B-, C-) lose 60% or more.
    • Recent Trades: Deals in New York and San Francisco have occurred at 66% to 80% discounts to pre-COVID valuations.

Timeline and Liquidity Constraints

  • Maturity Wall: $2.6 trillion in commercial real estate loans are maturing between now and 2029, requiring refinancing at higher rates.
  • Projected Stabilization: Reckler predicts stability will not occur until 2025; the current phase is "early innings."
  • Lending Behavior: Traditional first-mortgage lenders are retreating from the market due to regulatory and shareholder pressure.
    • Current lending is limited to "best customers" and projects.
    • Sideline liquidity exists but is primarily opportunistic rather than structural.

Adaptive Reuse and Conversion Challenges

  • Reinvestment Thesis: Van Nieuwerberg identifies a need to reallocate excess office space to other uses (housing, retail, last-mile logistics, medical, education).
  • Physical Limitations: Only 10–15% of U.S. office buildings are physically suitable for residential conversion (approx. 400,000 potential units).
    • Barriers include non-operable windows, floor plate depth, lack of plumbing/stairwells, and zoning codes.
  • Economic Feasibility: Conversions face a "narrow path" to profitability.
    • Requires cheap acquisition basis, high future rental rates, and manageable construction costs (hard and soft).
    • Affordable housing mandates often destroy the Net Present Value (NPV), requiring subsidies.
  • Duration of Crisis: The cycle is described as a "train wreck in slow motion" with potential lags of 5–7 years due to lease roll-offs, refinancing delays, and construction timelines.

Impact on Banking and Financial Stability

  • Regional Bank Vulnerability: Small regional banks (<$250M in assets) hold ~70% of CRE debt and face significant duration and funding risks.
    • CRE exposure for small banks can be 280% of equity; medium banks ~180%; large banks ~55%.
  • Consolidation Forecast:
    • Reckler predicts 500–1,000 fewer regional banks over the next two years via failure or consolidation.
    • Van Nieuwerberg warns ~200 small banks could fail, citing parallels to the 1980s S&L crisis (which cost taxpayers $150B).
  • Loss Scenarios:
    • If office values drop 40–60%, typical capital structures (30–40% equity, 60–70% debt) result in wiped-out equity and significant debt losses (30–50%).
    • Recent recapitalization deals have seen loan principal written down to 50 cents on the dollar.
  • Broader Economic Risk: Tightened lending standards (as tight as during the GFC and COVID) are spilling into corporate, consumer, and credit card loans.
    • Forward-Looking Statement: Van Nieuwerberg benchmarks a potential mild recession driven by this credit crunch.
    • Banks are over-levered (10:1 ratio) and losing deposits due to higher rates, creating a contractionary feedback loop.