Jamie Dimon predicts more banking pain from real estate … growing problems with multifamily commercial real estate … are lenders beginning to repeat the same problems from 2007?
The commercial real estate market is deteriorating.
Regular Digest readers know that for months, we’ve been running a “commercial real estate watch” segment to monitor this critically-important sector of the U.S. economy.
The same factors that resulted in a handful of banking failures this spring are creating cracks in the foundation of the $20-trillion commercial real estate sector. If defaults snowball, it will have an enormous impact on the U.S. economy.
Well, the stories are coming faster and faster.
Let’s begin with Monday’s CNBC article featuring commentary from JPMorgan’s CEO, Jamie Dimon
Here’s CNBC:
Deposit runs have led to the collapse of three U.S. banks this year, but another concern is building on the horizon.
Commercial real estate is the area most likely to cause problems for lenders, JPMorgan Chase CEO Jamie Dimon told analysts Monday.
“There’s always an off-sides,” Dimon said in a question-and-answer session during his bank’s investor conference.
“The off-sides in this case will probably be real estate. It’ll be certain locations, certain office properties, certain construction loans. It could be very isolated; it won’t be every bank.”
Sure, it won’t be “every” bank, but my money is on it being less “isolated” than Dimon says.
After all, regional banks are responsible for the overwhelming majority of loans to the commercial real estate sector. Bank of America puts the number at roughly 68%. So, let’s size-up just how big this issue might be.
This comes from Dimon’s own analysts at JPMorgan:
We expect about 21% of commercial mortgage-backed securities outstanding office loans to default eventually, with a loss severity assumption of 41% and forward cumulative losses of 8.6%…
Applying the 8.6% loss rate to office exposure, it would imply about $38 billion in losses for the banking sector…
Does that sound isolated?
We’re already seeing some troubled banks reducing their exposure to real estate
Take PacWest, which we’ve highlighted here in the Digest in recent weeks.
The bank’s stock has come under enormous pressure since March as banking contagion has spread. As you can see below, investors are down nearly 75% since March 1st.
Chart showing PACW falling nearly 75% since March 1, 2023
Source: StockCharts.com
Well, Monday brought word that PacWest is unloading dozens of properties to Kennedy-Wilson Holdings, which is a large real estate investment trust (REIT).
From CNBC:
Regional lender PacWest Bancorp said on Monday it agreed to sell a portfolio of 74 real estate construction loans with an aggregate principal outstanding balance of around $2.6 billion to a unit of Kennedy-Wilson Holdings.
PacWest said in a filing it will also sell an additional six real estate construction loans with an aggregate principal balance of around $363 million to Kennedy-Wilson…
PacWest is one of several U.S. regional lenders whose shares have been hit by investor concerns over the health of the banking sector following the collapse of three banks since March…
But while regular Digest readers are familiar with this “office/regional bank” trouble, the ripple effects are now spreading
So far, our analysis has focused on the “office” part of commercial real estate. But the sector is far larger than just office.
Broadly speaking, commercial real estate refers to any property used for business-related purposes. So, that could be a single storefront, a big shopping center, a warehouse, or even residential properties with five or more units paying rent.
Let’s zero in on these multifamily residential properties for our next story.
Yesterday, The Wall Street Journal ran a piece highlighting Jay Gajavelli, a real estate investor who built a rental apartment empire in Houston consisting of more than 7,000 buildings.
You might even know Gajavelli since he pitches his “double-your-money” real estate strategy on YouTube. From one of Gajavelli’s pitches:
I never worry about [the] economy now. Even if [the] economy goes down, still I make money.
Well, Mr. Gajavelli, I’d like to introduce you to reality.
From the WSJ:
In April, Gajavelli’s company lost more than 3,000 apartments at four rental complexes taken in foreclosure, one of the biggest commercial real estate blowups since the financial crisis.
Investors lost millions. Gajavelli didn’t respond to requests for comment.
His company had taken out commercial real-estate loans that carried floating interest rates and were adjusted each month. Those types of loans in 2021 offered initial rates as low as 3.5%.
Everything changed when the Federal Reserve began raising rates last year, driving up monthly loan payments.
Inflation contributed to higher expenses, and [Gajavelli’s company] couldn’t raise rents fast enough to keep pace. After bills went unpaid, company properties went into foreclosure.
Think Gajavelli was alone in taking out variable-rate loans?
Not so much.
From a different WSJ article earlier this month:
…Property buyers loaded up on unusually large amounts of variable debt during the pandemic.
In 2021 and 2022, the share of floating-rate loans in total CMBS issuance was around 60%, according to Trepp data.
Back in 2005 and 2006, when interest rates were also rising, the share was below 15%.
There’s no way around it – more defaults are coming.
To illustrate, let’s return to our original WSJ article:
Gajavelli is one of thousands of real estate entrepreneurs in the U.S. known as syndicators. Many have come under similar financial pressures and hold properties they can no longer afford.
From 2020 through 2022, real estate syndicators reported raising at least $115 billion from investors, according to a Wall Street Journal analysis of Securities and Exchange Commission filings.
So far, defaults have been rare. But real-estate analysts and property investors anticipate a wave of foreclosures ahead…
Many syndicators are racing to either raise funds or sell properties before tipping into foreclosure.
Most hold balloon-payment loans that require repayment when they come due this year or next. Those syndicators face large payouts at a time when getting new, more affordable property loans will be difficult.
Even firms with multibillion-dollar portfolios have used syndication to buy apartment buildings that no longer make enough money to cover debt payments, bond documents show.
But don’t worry – I’m sure the problems will be “isolated,” just like Dimon says they’ll be for banks.
Speaking of banks and real estate, idiocy is repeating itself
Remember the whole housing crisis of 2007 that nearly took down the U.S. banking system? Do you recall what caused that?
In large part, it was banks extending risky loans to subprime borrowers.
But we’ve learned, right? There’s no way our lending institutions would repeat that same mistake again…
Well, feast your eyes on this delightful MarketWatch headline from Tuesday:
Home buyers will now be able to put down as little as 1% on their home, Rocket Mortgage says
Rocket Mortgage is allowing low- and moderate-income would-be homeowners to buy homes with just 1% down on their purchase price.
And I know this makes you nervous, but don’t worry! This is in no way, shape, or form like the “no down payment” mortgages in the subprime crisis. After all, this is an enormous “1%” down payment. See? It’s miles above 0%!
Rocket Mortgage’s CEO Bob Walters assures us that borrowers will have to meet “stringent” credit standards. In fact, Walters is so certain that nothing could go wrong here, that this new 1%-down loan doesn’t even require the borrowers to pay mortgage insurance. Rocket Mortgage will pay it for you!
(Is it relevant that Rocket Mortgage reported a net loss of $411 million in Q1?)
I hope this works out, but I’m wary. Whatever the specific outcome, looking broader, there’s more fallout coming. Unfortunately, real estate is so large and intertwined with complementary sectors that there will be collateral damage – we just don’t know exactly how much, or where.
