Key Points
- The collapse of Silicon Valley Bank and Signature Bank has raised concerns about regional banks’ exposure to the commercial real estate sector.
- Regional banks are providing a significant amount of real estate lending and have a fair amount of exposure.
- The liquidity and condition of office real estate are the two main issues to consider.
- The office sector is facing significant challenges, and it will take time for it to recover.
- Regulators will play a crucial role in determining the outcome of the office real estate sector.
The office real estate sector and the regional banking sector have been a cause for concern in the financial market. The collapse of Silicon Valley Bank (SVB) and Signature Bank, along with the hasty acquisition of First Republic Bank, has raised questions about the potential crisis that regional banks may face in the commercial real estate sector, particularly the office sector.
Sonny Kalsi, co-CEO of BentallGreenOak, a leading global real estate investment management adviser, discussed the prospects of the office real estate sector in a recent podcast. Kalsi noted that while big banks have reduced their lending to real estate, non-bank lenders have stepped in to bridge the lending gap. Regional banks have become a significant source of real estate lending over the past five years, accounting for at least one-third of the total real estate lending. This indicates that regional banks have a considerable exposure to the sector.
However, Kalsi highlighted two key issues affecting the sector: liquidity and the condition of office real estate. He stated that there is a lack of financing available in the market, as big banks are not providing it anymore, and regional banks have also stopped lending. While certain segments of the real estate sector, such as industrial and multifamily, are expected to be less problematic, the office sector presents significant challenges. Kalsi described it as the “800-pound gorilla sitting squarely in the middle of the room.”
When asked about the end game for regional banks from a systemic risk and banking angle, Kalsi acknowledged that there could be a time bomb, but it would have a long fuse. Unlike securities that can be rolled over in the capital markets, many bank loans require the banks themselves to trigger a default. As a result, assets in technical default are being rolled over by banks because borrowers are currently unable to refinance them due to the illiquid market. The actions of regulators will have a significant impact on when and how the default time bomb goes off.
Given the challenges faced by the office sector, Kalsi compared it to the retail sector ten years ago, which also experienced a significant downturn but eventually found its footing. He suggested that the office sector would take time to recover, and regulators would need to decide whether they would be patient or not. Kalsi expressed hope that another systemic risk event could be avoided but mentioned that certain lenders with a high percentage of their book in commercial real estate may face issues. He predicted that more bank failures could occur in the future.
In terms of practical considerations for asset owners and allocators, Kalsi emphasized the importance of having the right people managing their portfolios. He also highlighted the need to think about the asset class and how to manage existing portfolios through the current challenges. Kalsi mentioned the denominator effect, where equity market downturns result in alternatives representing a larger percentage of portfolios, but he suggested that this could be an opportunity. He encouraged investors to consider going on the offensive in addition to playing defense.
Overall, the outlook for the office real estate sector remains uncertain, and the actions of regulators and banks will play a crucial role in determining its future. Investors and asset owners should carefully consider their portfolio management strategies and seek opportunities in this challenging environment.
All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: ©Getty Images/ FangXiaNuo
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