Source: Zhitong Finance Author: Rousseau
Commercial real estate is viewed by US stock investors as the area most likely to trigger a systemic credit incident; as commercial real estate prices plummeted, investors pulled out of real estate funds one after another.
The current liquidity pressure faced by regional banks in the US, the continued slump in US office prices, and high benchmark interest rates have caused some retail investors and fund managers to once again be bearish on one of their favorite industries: commercial real estate. Following a sharp rise in shorting in the US stock regional small to medium banking sector due to turbulent commercial real estate performance at the end of January this year, shorting forces have recently returned to commercial banks with commercial real estate exposure, especially regional banks.
On January 31 of this year, New York Community Bank, which took over “Signature Bank” (Signature Bank) during the US regional banking crisis last year, decided to cut dividends and reserve reserves, causing its stock price to plummet by a record 38%, and dragged down the KBW Regional Banking Index (KBW Regional Banking Index) to record the worst trading day since Silicon Valley Bank (Silicon Valley Bank) went bankrupt at the speed of light in March last year. In the US, small and medium-sized regional banks are often very exposed to commercial real estate, and may be adversely impacted much more severely than larger commercial banks.
Commercial real estate can be described as the area most likely to trigger a systemic credit incident by US stock investors. As commercial real estate values plummeted, investors pulled out of real estate funds one after another.
By the close of the US stock market on Thursday, the trading price of Data Center Real Estate Investment Trust (REIT) Equinix Inc (EQIX.US) had fallen to its lowest level since January. Previously, the well-known shorting agency Hindenburg Research (Hindenburg Research) said it was shorting the company's stock, and S&P Global (S&P Global) said earlier this month that assets such as REIT are currently the largest shorting category in the world.
In recent weeks, news from many US regional banks, including New York Community Bank (NYCB.US), and sluggish stock price trends have made investors uneasy. Even large multinational commercial banks such as Deutsche Pfandbriefbank AG (Deutsche Pfandbriefbank AG) have set up more reserves for real estate loan losses. The downturn in commercial real estate in the US has even affected commercial banks in Japan. Aozora Bank Ltd. (Aozora Bank Ltd.) warned in January that the bank's investment in US commercial real estate could suffer huge losses. This heightened tension in the US commercial real estate market, causing bank stocks in the Japanese stock market to plummet for a while.
This concern reflects the continuing downward trend in US commercial real estate values under the pressure of high interest rates, and the difficulty of predicting which specific loans may collapse. The reason behind this situation may be that the COVID-19 pandemic has caused people to habitually switch to remote work (especially in tech companies, where more and more employees are choosing to work remotely), and interest rates quickly rose to the highest level in 22 years after the start of the Federal Reserve's interest rate hike cycle, making it more expensive for struggling borrowers to refinance.
According to a Real Assets report released by MSCI on Wednesday, the value vulnerability of commercial office buildings in the US and Europe continues to exist, which in turn caused the value of commercial office buildings in the US to plummet by about 15.2% in the year ending February this year.
Daniel McNamara (Daniel McNamara), founder of Polpo Capital Management, is shorting some investment targets in the commercial real estate sector. He said, “Investors have finally realized that interest rates will not return to a level close to zero, and the commercial office industry has been changed forever.”
“Air forces” gather at financial institutions with commercial real estate exposure
Generally speaking, shorting forces usually choose to borrow stocks and sell them, betting that they can make a profit by buying back the stock at a lower price later. They also use credit derivatives, indices, and stocks to short landlords' assets, the subject of landlords' debts, and lenders.
According to S&P Global (S&P Global) statistics, close to 13% of New York Community Bank shares are currently shorted, far higher than 3% in November. One important reason is that the bank is an important player in New York's multi-family apartment buildings, where rents are controlled or forced to stay within a stable range, so the actual value of these apartment buildings has been falling rapidly.
Higher borrowing costs have led to a drop in the value of multi-family homes — cooling demand and increased supply have also affected prices
Although office buildings are an area that real estate investors are particularly concerned about, New York Community Bank's largest real estate exposure comes from multi-family homes, and the bank has about 37 billion US dollars in condominium loans. Nearly half of these loans are funded by rent-regulated buildings, making them vulnerable to New York State regulations passed in 2019 that severely limit landlords' ability to raise rents.
At the end of 2023, the US Federal Deposit Insurance Corp. (Federal Deposit Insurance Corp.) sold loans of about $15 billion. These loans were guaranteed by rent-controlled buildings and received a transaction discount of about 39%. Another sign that these apartment buildings are facing challenges is that, according to Trepp's analysis based on the construction time of these properties, as of December of last year, the proportion of rent-stable apartment buildings with securitized loans in New York City was about 4.9%, which is three times the ratio of loans in arrears for other apartment buildings.
Carson Block, founder of Muddy Waters, said in a recent interview that since disclosing its short position on Blackstone Mortgage Trust (Blackstone Mortgage Trust), which focuses on commercial real estate in the US and Europe, concerns about the difficulties in the multi-family housing market are one of the reasons why the company is increasingly “bearish” on Blackstone Mortgage Trust, adding that this may also have a negative ripple effect on the stock prices of some smaller commercial banks.
Statistics show that nearly three-quarters of SPDR's S&P Regional Banking ETF (S&P Regional Banking ETF) holdings have been shorted. This ratio has increased by more than 10 percentage points since the beginning of last week.
At a time when the scale of short bets recently surged, traders generally drastically lowered their expectations about the timing and extent of the Fed's interest rate cut. The market's expectations for the Fed's interest rate cut this year have continued to cool down, from the 150 basis point rate cut expectations at the end of last year to the current rate cut of about 75 basis points — which is in line with the December FOMC interest rate bitmap. According to the latest data from the “CME Federal Reserve Watch Tool”, the probability of interest rate cuts in June is around 60%. Interest rate futures traders previously generally bet that March will be the time point for the first time to cut interest rates. Federal Reserve officials have recently said that after experiencing a series of sharp interest rate hikes since 2022, they are in no hurry to launch monetary easing policies.
Fitch Ratings (Fitch Ratings) said in a report on Wednesday that the recovery pace of the US commercial office market will take longer than after the financial crisis. The rating agency predicts that by 2025, the US CMBS office default rate will reach nearly 10%, surpassing the historical peak after the global financial crisis.
More and more investors are worried that the commercial real estate problem may have some systemic effects. Among global fund managers surveyed by Bank of America Corp. (Bank of America Corp.), more than 40% now believe that the US commercial real estate sector is the most likely source of systemic credit incidents, compared to less than a quarter in January.
The problem with apartment loans means that investors are also paying more and more attention to the performance of commercial real estate mortgage certificate assets, as these debts are about to be repaid at maturity.
CRE Clos bundles variable interest short-term loans, which are commonly used to acquire and refurbish leased buildings. These borrowers have been struggling after being hit by rising benchmark interest rates and falling valuations in some markets.
According to data compiled by S&P Global Data, Arbor Realty Trust (ABR.US), one of the financial companies that issued these securities assets, had a short share of about 34.5% of the issued shares, compared to about 21% in September.
When it comes to commercial real estate, there is still no shortage of analysts who are relatively optimistic about the future market
Landlords and owners also appear to have been targeted. Hindenburg said that Equinix abandoned the planned bond issuance after the shorting agency's report was published, and that the company manipulated accounting operations. A spokesperson said the company is investigating the allegation and will respond in due course.
According to S&P Global statistics, the share of Hudson Pacific Realty's bears in issued shares soared to nearly 11%, the highest level since October last year, compared to about 7% at the beginning of this month. The ratio of short bets on Boston real estate has risen to nearly 2.2%, up from about 1.2% in December last year, but it is still far below the 8.6% level in the middle of last year.
Kevin Brown (Kevin Brown), a stock analyst from Morningstar (Morningstar), a world-renowned rating agency, is relatively optimistic. The analyst said that most REITs assets focus on having the most fundamental building targets, so they can avoid many of the barriers faced by property owners with poor locations or poor quality. He expects the US real estate market to stabilize over the long term, and office owners will not have to provide too negative incentives to attract tenants, but he anticipates that large-scale recovery may be difficult. “Rigid demand for office buildings will still exist, but it won't be as hot as it was in 2019.” The analyst said.
A Blackstone Mortgage Trust spokesperson said the company raised liquidity to close to record levels and reduced leverage while maintaining strong profits. Arbor declined to comment, while Hudson Pacific and Boston did not respond to media requests for comment.
US commercial real estate woes may continue until 2025
Although commercial real estate prices in the US have been falling, private equity buyers have mostly waited and waited for the value to fall further as borrowers begin to default and become more troubled as loans deteriorate. But that may be changing now. Blackstone Inc. (Blackstone Inc.) president Jon Gray said this month that commercial real estate values are bottoming out, and soon there will be opportunities to buy assets from banks and insurance funds that may have to be sold at a discount.
European real estate capital inflows have turned negative
Another source of sales may be real estate funds, which have seen a surge in divestments in recent months. According to data compiled by Morningstar (Morningstar), as the value of European real estate funds declined, investors withdrew nearly 1.3 billion euros from European funds in February, while the scale of divestment in the same period last year was only slightly higher than 25 million euros.
For example, as the US and European real estate markets continued to slump, Credit Suisse Real Estate International lost about 22% of its investment volume in 2023. Documents show that by the end of last year, investors had requested the asset management company to redeem about 23% of the fund's investment share.
Currently, commercial office buildings in Western countries are still the most obvious source of problems in the commercial real estate market. According to MSCI Real Assets data, these buildings are collateral for more than 20% of commercial real estate loans due to expire in 2024. The agency said landlords of these buildings may have a harder time getting loan extensions compared to landlords with other assets.
The more serious situation is that, according to Trepp's statistics, by the end of 2025, the US banking sector will face commercial real estate debt maturing up to 560 billion US dollars, accounting for more than half of the total real estate debt due during the same period. In particular, small to medium regional banks, such as Community Bank of New York, which are highly exposed to commercial real estate, are likely to be more negatively impacted than larger commercial banks because they lack large credit card portfolios or investment operations to protect themselves from the impact.