Fearing losses, banks are quietly dumping real estate loans
nytimes.com
nytimes.com
And that's what I think is behind much of the push for RTO. While a lot (if not most) office space is rented, corporate executives are the kind of people who could have a lot of money invested in commercial real estate. They see this large threat to their portfolios, so they're trying to keep their assets from depreciating.
“Real estate always goes up” is treated like a damn entitlement to the point that the financial well being of everyone under 40 today has been sacrificed to it. In 2008 it felt like the entire real economy was put on the chopping block to bail it out.
I’d love for a real estate market that looks like Japan. That way the real economy built around people actually doing things could flourish free from endless real estate idle rent extraction.
The de-risking has come in the form of artificial scarcity caused by zoning gatekeeping and outdated fire code, amongst other things. It’s time North America took a hard look at the root causes and fixes them before there is a crisis of confidence in leadership (which is already happened to me - I’m moving out instead of buying in to the insanity.)
We need to double the number of bedrooms in most major cities.
Right now.
But that's because it's too expensive to live there, so people move to outlying areas. But if the cost of housing starts to drop, people will start moving in, which will stymie the cost declines.
I'll admit that I'm not intimately familiar with all of the large cities in the US, but Seattle would be a slam dunk. The suburbs are way more populace than the city itself.
Same with San Francisco, although that city has more problems than just a shortage of housing.
I'm not sure to classify New York City, but Manhattan could easily double its bedrooms with no shortage of demand.
But you're gonna make it a lot more livable and arrest the rate of inflation.
* No minimum lot size
* No parking space requirements
* No single family zoning in the city - minimum is multi-family, 15 stories.
* No requirement to match the character of the neighborhood
* No height based additional setbacks
* No rent control
* Get rid of the anti-dorm laws[1]
* No historical preservation without the city buying the property in question
* No building plan for the city - replace it with a "shall issue" policy where the city has to have some affirmative reason to block the permit or it gets issued by default.
There's probably a bunch more that should probably be done away with; those are the ones I can think of off the top of my head.
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1. It's very common in cities to ban dwellings that house more than x (typically 4) un-related adults.
No. I mean double the total number of bedrooms.
It is absolutely necessary public policy to completely gut the price of real estate across the country. I am aware that it'll be painful.
You don't need to double the area, you just need to double the density, which is easily done by eliminating exclusionary zoning. The scarcity is artificial.
I think you should double-check the numbers on this before you assert something is easily done. I live in NYC--are you saying we should live in half the space that we currently live in? A 400sf 1BR apartment should now be a 2BR apartment? Please draw a functional layout for this apartment.
And to what end? The population of NYC is ~8 million. You think the population should double? Where are all of the new people moving from, and what should we do with the houses they are currently living in? You don't need to double the total supply of housing to dramatically affect the housing cost--you just need to increase the supply of housing for the people who are looking right now, which is a much smaller number than the total number who live in the city.
Instead what we see today in NYC is the same as what we're seeing around North America. NIMBYism, heritage protections, gatekeeping, lawsuits, FUD, political grandstanding, etc.
For anyone in their 20s or 30s.. you only have so many years even if it seems life is long. If your current city makes it impossible to have the housing you want you have two choices. Try to change it, which is noble but can take many decades. Or move.
I can't fault anyone for trying to change it since improvement is a great cause. But do you want to find yourself 60 years old, still waiting for those changes?
I'm on the younger side of GenX so not in my 20s anymore. But when I was in my 20s I wanted to desperately live in my chosen city (Manhattan). I tried everything but it was way too expensive to reasonably rent, forget buying. I gave up and moved and bought a nice house for less money than a closet in Manhattan.
These things are easily found outside of Manhattan (in my example, or whichever large downtown area you prefer).
In my little suburb I can walk to just about everything I could need, multiple farmers markets for fresh food (probably more than in Manhattan since there are many farms within an easy drive; not too many farms in Manhattan!), top rated schools, public parks, libraries, theaters, etc.
The only thing missing here compared to Manhattan is tons of bars within walking distance for the nightlife. There are a couple breweries within walking distance so that's good enough for me, given all the tradeoffs.
True, but in my experience every place that’s satisfactory on these fronts is also getting insanely expensive, even the suburban areas. I currently live in a walkable small town and COL in walkable areas is essentially the same as, say, Astoria, without nearly as many transit options or amenities.
Well it's more than that (where is it cheap 20 minutes from Manhattan?), but in general you're right.
Move out to the suburbs, far enough that it's cheap(ish) but you can still visit.
Arguably the '08 crash was bad long term too. As far as I've read, a lot of people got out of the industry after that, which made it even harder to build.
fify,
the problems are class-based, not age/generation-based. the intergenerational conflict is fed by the 1% to keep us from paying attention to how they are robbing us.
At every age baby boomers were more likely to own a home than millennials at the same age.
https://research.stlouisfed.org/publications/economic-synops...
In some way I hope it crashes as well, just so I can get back in if I wanted too, but on the other hand, so many of my friends and family have bought into the "real estate always goes up" mantra that if it goes backwards, they will be ruined financially. With interest rates up and their mortgage repayments going up dramatically, I've already seen more divorce than I ever imagined I'd see. The financial pressure just broke marriages.
In hindsight, I'm probably better off now that I moved away to a cheaper place in the mountains and leave nearly debt free. I invest my money rather than give it back to the bank with interest.
Real estate took a bath in 2008. So much that it scared developers and investors so much that they slowed building to ridiculous paces
If you want reasonable housing prices in the US you need either:
- to change demand so people want to leave today's dense and expensive cities and stop competing-up the prices. The "RTO is all about commercial real-estate" true-beleivers think remote work alone could do this, but the last few years aren't providing strong evidence of that. Density and geography have other appeals.
- or, some way to re-start massive construction in those in-demand areas to push rents and individual-unit pricing down... but in this case, the price of the real land would actually go way up (there's no development if there's no future value > present value)
Sure, many of them do.
But there's something else they are far more invested in: their company (through huge pay and even larger stock option grants).
I don't buy this meme that CxOs are willing to hurt company efficiency just to protect personal real estate investments, when for nearly all executive (I'm sure there's some exception but not enough to matter) they own far more share in the company than in their side business in real estate.
Things like automatic enrolment in 401K plans, or automatically bumping employee contributions by 1 percent will also benefit the broad market and funds.
[1] https://newsletterhunt.com/emails/12216
[2] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2632024
I do. Think of all the inefficiencies you've seen reported (or reported yourself) and nothing is done. On the grand scale companies have abandoned the idea of retaining talent altogether, with best performers leaving over the refusal for some 10% CoL raise and hiring/training a new person for 20% more.
I think the most dangerous part is that these aren't rational actors fully focused on maximizing long term profits. So they aren't making seemingly rational decisions.
As an alternative viewpoint, there are probably a lot of peer pressure from people we never see nor hear about that can influence these CxO's as well. They are still people at the end of the day (85% of the time or so). if their friends or [company they admire] do something they will follow suit, no matter how incompatible it is with their company.
Many large corps are fine with being on the thick part of the Bell curve, their managers can easily scale if the board says they should output more, they are essentially linearizing their whole company around a point and they can scale up/down around it.
It works until someone else innovates and beats them, and then the loop repeats.
It's in some sense good that CxO's behave like this, because it leaves opportunities for smaller companies all the time.
By far, the biggest investor in real estate is government pension funds. Government has every vested interest to enforce RTO, because without it, if companies stop leasing space, then government pension funds will be unable to pay out.
All too often people assume 'greedy bankers' are the ones who are going to lose. That's wrong. Bankers are the middle men. Bankers don't care. They'll get their cut.
Thus... there's no other option. Government has had to seek out incredibly dangerous investments. The largest purchaser of hedge funds, venture cap, etc... is pension funds. People claim evil capitalists are driving greed in expected return. To the contrary. The government is demanding high rates of return, and enterpreneurs and capitalists are providing a supply.
Then, when things go wrong as they inevitably will, because you can't beat the market's valuations, everyone points fingers. But the demand for the high rate of return is primarily driven by government pension funds. Without them, a more modest rate of return would be demanded, and companies like BlackRock, Vanguard, etc, wouldn't be incentivized to purchase commercial or residential real estate in those amounts.
[1] https://www.travelandleisure.com/travel-news/monuments-hotel...
[2] https://newsroom.chipotle.com/2021-04-27-Chipotle-Invites-Fa...
The push to RTO boils down to:
- leaders want the over-committed. Remote doesn’t feel like that.
- they miss working in person as a team and the fuel it provides for getting things done. Remote doesn’t feel like that.
It is almost universally a gut-sense that has driven the effort.
I think it does make sense for the leadership team and their close team members to work in person most of the time.
But there’s a funny flip side to this - almost all of them are on the road most of the time. Coming back to an empty office sucks.
I’ve been building remote-first companies my whole career. I prefer frequent onsites to offices.
But in the end, the prestige of the office, social cohesion of organizing life around it, and personal sense of power from having a team around you are unlikely to be replaced by any alternative for most leaders.
Most of them are 5 year (there are others), interest only and a massive balloon payment at the end. They are written based on the income of the property & its value. We're seeing these markets unwind, and it isn't going to be pretty.
Commercial property across the board (not just offices) has been in a strange place for a long time, and it isn't getting better.
https://www.reuters.com/business/finance/us-bank-regulators-...
Have you written about this anywhere? I can’t decide if it was mindnumbingly boring or the ride of a lifetime (leaning towards the latter).
Yes this article is about commercial real estate but it shows something is actually very broken from a credit market perspective - my loan is probably going to be underwater for the financier (JPMC assumed from FRB) for the rest of the term (just on the fed rate, but then I'm also making a margin on the leveraged capital. And tax deductions on the interest.).
> but then I'm also making a margin on the leveraged capital.
Do you mind expanding on this? I’d like to understand what you are doing, as a fellow ridiculous mortgage holder.
How do you use the leverage (debt) from the mortgage to put in a 5% investment?
It makes sense that some banks might be offering them now at 7% since they have little to lose but I don’t think low interest longterm fixed mortgages are really possible without significant government interference (like in the US).
From the piece:
> For investors, the attraction of snapping up discounted commercial real estate loans is that the loans could be worth a lot more if the industry recovers in the next few years. And in the worst-case scenario, the buyers get to take possession of a building at a discounted price after a foreclosure.
“Buy when there is blood in the streets” — Baron Rothschild
The book value of the property is related to prospective rental income. It is - bizarrely - sometimes more profitable for owners and investors to maintain the fiction of high rental value without any income than to drop the rental value to something realistic and take a realised loss. Even if that's generating real income.
I would guess it's the same in the US.
This leans suspiciously towards subprime-all-over-again, where the nominal value and security of investments is being wildly overstated.
At some point it's going to have be unwound, which will create some interesting readjustments.
In the US it's more or less impossible for the loans to be worth "nothing". They are usually secured by the property itself. But the loan itself is worth less if it's in default, rather than not quite yet in default. So it can be a better deal for a bank to sell it away now rather than later.
But the other side is possible too: even if the loans had a guaranteed long term value (like SVB's bonds), they could be an issue in the short term. More so if getting the value out of the loan requires both time and effort (eg: legal costs).
Totally disagree. A loan can absolutely be worth nothing, especially if it is a 2nd/subordinated lien.
Imagine you buy a house for $1000 with $800 borrowed ($700 first lien, $100 second lien.)
If the home goes down in value 30%, the second lien is worthless. The administrative and legal cost of recovering the second lien may be greater than the recoverable value of the second lien, which in this case is $0.
Just in the obvious case, if the borrower continues to pay, the lien is worth the future value of its cashflows. Not everyone who goes underwater on a loan simply stops paying.
In the US, even loans in default tend to have some value, because speculators are willing to buy the debt and attempt collection.
Loans go to zero. It happens in real estate, it happens in oil and gas, it happens in other places I'm sure. It's not especially common, but it happens.
It is common, but at the end of a cycle. The chances of second lien loans being worth zero are higher and higher as leverage increases. This is for two reasons:
1. The greater the leverage, the smaller the required downturn to turn everything underwater. With 5% down mortgages, a 5% decrease in housing values makes you underwater (esp once you consider transaction fees.)
2. The greater the under-water, the less incentive owners have to continue paying, especially in non-recourse jurisdictions where no bankruptcy is required. Owners do "jingle-mail" where they mail the keys to the bank (figuratively) and walk away without having to declare bankruptcy. The bank is left with the mess.
Freddie Mac is already pushing to do 2nd lien HELOCs (https://www.housingwire.com/articles/freddie-macs-proposed-h...) and Fannie is considering it.
People keep saying this, but the only time they can come up with examples are when the owner wants out of the property. In the case of a home loan, being underwater is meaningless if you're not going anywhere. Most people will continue to pay because they need a place to live. I have yet to hear of someone who was underwater on their primary home loan and decided to stop paying it and default just because. For an investment property I could see that happening. For the house that you plan to live in for the next 20 years? No.
Only if you have a real choice. Reasons people will default:
- Divorced, force seller; especially common as finances go downhill
- floating rate on 2nd mortgage/HELOC is no longer affordable
- Lost job, have no money to pay mortgage. defaults
- Job change with lower income. Have money, but not enough to keep up with payments
- property taxes re-assessed, no longer affordable. tax liens pile up on home
Correct, but once underwater, an default renders the loan worthless.
Underwater+Default --Usually--> Worthless 2nd lien
>> Just in the obvious case, if the borrower continues to pay, the lien is worth the future value of its cashflows. Not everyone who goes underwater on a loan simply stops paying.
Totally agree, but not everyone has a choice (divorce, lost job, floating rate rises, wages fall, etc.)
>> In the US, even loans in default tend to have some value, because speculators are willing to buy the debt and attempt collection.
Yes, for recourse states, not for non-recourse states because the later only offers the liquidation of the home as collateral and nothing else. https://www.quickenloans.com/learn/the-difference-between-re...
Incorrect. A loan in default can usually be pulled out of default, or otherwise re-structured to keep the borrower current. They are not worthless. In fact, there's a whole sub-industry devoted to this called "special servicing". Even for underwater loans, people tend to want to repay their loans.
You are directionally correct that as a loan gets further into default, it loses value, but this is not a step function, and it certainly doesn't happen instantly on default. You're over-indexing on an exceptional outcome from an exceptional time -- even in 2008, the vast majority of distressed borrowers weren't walking away from their loans.
Banks dont want to be in the business of landlording properties which have gone into foreclosure or bankruptcy. However, there are players out there who are happy to take on the job of landlording or renegotiating debt in bankruptcy -- if they can enter the investment at a favorable price. Those are the buyers.
Other investors clearly think that the loans have some value. Some loans may not go into default, but banks down want depreciated assets on their books, other lenders may prefer to restructure the loans at higher interest etc.
A lot of commercial loans require certain rental rates, which is why you’ll sometimes see large vacancy instead of price reductions. This could be one tool that allows that to change. Maybe with a price cut the tenants will be viable, but the bank would rather offload that risk to someone willing to restructure the loan.
There are many investors who would like to buy the loan for cheap due to their risk tolerance and/or recouping time horizon and/or non-obvious benefits.
Firstly, it is clear that publicly listed banks have to remove loss makers from their loan portfolio because it affects their quarterly earnings. This is the reason why they'd take a small loss now than a large loss later.
Among the buyers, there could be someone who wants to own the land and the building for future generations - and buying the loan for cheap and foreclosing it might get them an amazing real estate. They could potentially keep this valuable thing in a trust for future generations - aka their time horizon may be over 50 years to recoup it.
Other investors might already be a roster of clients who want cheap office space but might not be able to buy the undervalued building. Buying the loan for cheap lets them get some cash flow and later foreclose on the building so that the roster of clients can be filled in for future use.
Others have funds of corrupt money from foreign lands they want to put to taxable use.
The real value seems to be that there are buyers who want the building but don't want to meet the buyers at the price, so they'd rather buy the loan and hope the current owners foreclose.
Method = pay less than face value.