Friday marks Groundhog Day, and market observers can be forgiven if the worries over office buildings brings a sense of deja vu.
“Last March, as the U.S. banking crisis unfolded, investors quickly turned their attention to the next shoe to drop for the sector. And while the March event was all about interest rate risk, the next one was supposed to be about office commercial real estate loans,” say strategists at Barclays Capital led by Ajay Rajadhyaksha. “We were inundated by questions about how bad fundamentals in office CRE were, what the overall exposure for the U.S. banking sector was, and whether it was the catalyst that would spark a continued banking crisis.”
Their view back then was that the numbers were not large enough to rise to the level of a macroeconomic issue that would spark sharp Fed easing, a view they still share.
After this week’s news about New York Community Bancorp
and Aozora Bank
it’s “here we go again,” say the analysts, though this time they are also getting questions about credit on multi-family residential buildings, i.e., apartment buildings. The short answer first, the strategists still don’t see a problem.
The U.S. commercial real estate market is $5.6 trillion, of which multi-family is the biggest component, at more than $2 trillion. Some $1.2 trillion of that is guaranteed by the government-sponsored entities, Fannie Mae, Freddie Mac and Ginnie Mae.
The remaining credit risk outside of the GSEs is roughly $1 trillion, some $700 billion is within banks, with the rest split elsewhere between bond investors, insurers and mortgage real estate investment trusts.
Multi-family apartment building prices have dropped up to 20% from their peak in late 2022, and returns have been squeezed by the rise in interest rates. That said, the strategists say, not only are prices still up 20% from pre-COVID levels, vacancy rates are roughly the same, meaning unlike offices there is not the risk of empty apartment buildings. And even as the pace of rent growth has cooled, rents are still rising.
New York Community Bancorp was unusual in that 44% of its assets were commercial real estate loans, some 4 times more than its peers. And one-third of its assets were to multi-family lending, and it’s concentrated in Manhattan, with more than half subject to rent control. “There were so many factors specific only to NYCB that we think this bank’s challenges are not at all indicative of stress in the broader banking system from multi-family CRE,” say the Barclays strategists.
The Barclays analysts say that the areas of concern would be in floating rate loans, and they estimate about $400 billion of the $700 billion in multi-family loans are floating rate. Rent controlled delinquency rates are many multiples of those on market-rate apartment buildings, they add.
Also looking at the details of Signature Bank’s multi-family loans when it was liquidated by the Federal Deposit Insurance Corp., the Barclays analysts conclude a “defensible worst case” situation would be cumulative losses on the U.S. banking system of between 6% and 7% on those loans.
“We do not think actual losses will come remotely close to that. But even if our worst case does materialize, that implies $45-50 billion in economic losses for the entire U.S. banking system (from this asset class) – not remotely enough to matter at a macro level.”