Mark Heschmeyer of CoStar opens us up this week, outlining that distress in the office market is starting to trickle into bank portfolios. The CFO of PNC, for instance, noted on the company’s earnings call that nonperforming loans increased $210 million, or 11% quarter-over-quarter, with losses driven primarily by office buildings.

Jennifer Sor of Markets Insider reports on an investor survey showing that they’re generally bearish on the commercial sector, but 65% believe the US office market is in for a steep crash. Further, 72% said they think commercial real estate prices will bottom out before 2025. Further, around $155 billion of commercial real estate debt is currently at risk of default due to rising rates.

Indeed, Avison Young released its Q3 Office Report, warning against the debt wall about to hit the office market in 2024 and 2025. There are a record number of loans up for renewal.

Source: Avison Young (October 2023)

Further, leasing activity is down substantially: “Leasing activity temporarily paused in Q3, continuing the tear-to-date slowdown. Deal flow to date in 2023 is down 33.8% vs. 2000 to 2022 three quarter averages.”

Source: Avison Young (October 2023)

This is partially why we’ve seen an increase in office-to-apartment conversions over the past year, according to Philippa Maister of Globe St. There are 100 office conversions due to be completed by the end of 2023, with 42 being the annual average between 2016-2022. This represents over 60 million of office square footage that will become apartments.

“The leader in office conversions by square footage and as a percentage of total office inventory is Cleveland, with 11% planned or underway and just over 6% of the total 3.5 million SF designated for multifamily use. The city is followed by Cincinnati with 2.4 million SF (7%), Boston with 6.1 million SF (3.6%) – all for life sciences use, Houston with 5 million SF (2.5%), and San Francisco with 2.9 million SF (2.3%).”

China

China’s real estate sector has been in trouble for years, according to Charlie Campbell of TIME Magazine. Evergrande, the second largest developer in China, recently filed for bankruptcy, and the CEO was arrested. This has left 1.5 million consumers with unfinished homes or apartments. Since real estate accounts for about 30% of China’s GDP and 80% of household wealth, this is a massive headwind for the country.

It’s not just Evergrande, but the country’s largest developer, Country Garden, has also suffered significant losses and missed debt repayments. This reality has caused some bank runs as well as officials cracking down on negative social media sentiment. 

Charmaine Jacob of CNBC reports on China’s economic woes, highlighting that the International Monetary Fund recently noted that China’s reliance on investments in real estate has “run its course.” 

Source: Times of India (October 2023)

Vince O’Neill of Housing Wire reports on potential ripple effects, reporting that China’s real estate slump is “[f]ollowing a pattern eerily similar to the U.S. in 2008 and 2009. Lax lending standards and cheap credit, plus a popular belief that real estate values never decline, created a massive bubble.” That said, what could be bad news for Chinese investors, could bring capital to North America in search of safer yields.

“Even bad news often has a silver lining. As the Chinese real estate market declines, the U.S. residential market becomes a relatively safer landing spot for investment. In turn, this capital flow will tend to push down mortgage rates, potentially providing some relief from one of the biggest factors holding the US real estate market back from a full recovery.”

Clare Jim, Xie Yu, and Davide Barbuscia of Reuters report on the entire real estate sector in the country, noting that “developers accounting for 40% of Chinese home sales have defaulted on their debt obligations since 2021, according to JPMorgan. Those defaulted companies, mostly private, have issued around $110 billion worth of high-yield offshore bonds.”

Groups lobby Fed

Several industry groups and leaders have joined forces to lobby the Federal Reserve to halt interest rate increases. In a letter sent two weeks ago, the Mortgage Bankers Association (MBA), the National Association of Realtors (NAR), and the National Association of Home Builders (NAHB) sought to:

“Convey profound concern shared among our collective memberships that ongoing market uncertainty about the Fed’s rate path is contributing to recent interest rate hikes and volatility. This has exacerbated housing affordability and created additional disruptions for a real estate market that is already straining to adjust to a dramatic pullback in both mortgage origination and home sale volume. These market challenges occur amidst a historic shortage of attainable housing.”

Interest rates have hit record highs, according to the latest report from Freddie Mac, with the average 30-year benchmark rate now sitting at 7.57%.

Source: Realtor.com (October 2023)

Jeff Cox of CNBC reports on the letter, noting that the group explicitly asked the Fed not to contemplate further rate hikes. Further, the group requested that the Fed not sell its holdings of mortgage securities until the housing market has stabilized.

Angela Palumbo of Barron’s reports on the Philadelphia Fed President Patrick Harker, who recently stated that he believes the Fed should no longer raise rates. Harker is quoted as saying: “Absent a stark turn in what I see in the data and hear from contacts, both in one-on-one conversations and in forums like this, I believe that we are at the point where we can hold rates where they are.”

Pete Grieve and Brad Tuttle of Money Magazine report on this reality, highlighting that Fed officials have mostly signaled a more cautious approach and keeping rates steady for the next few meetings. Further, markets are mostly predicting rate pauses for the remainder of 2023 according to the authors.

Finally, Logan Mohtashami of Housing Wire reports on the latest inflation data, which he believes makes the case for more rate pauses. “Hopefully, with all the data about inflation and rates, it’s a good reason for the Fed to just chill, enjoy Halloween, Thanksgiving and Christmas, and let’s not play the Scrooge role now.”