As always, when it comes to real estate, Wolf Richter’s analysis and charts are very helpful.
Let’s take the office building story step-by-step:
Between 2010 and 2020, millions of square feet of office space were financed with unnaturally cheap credit.
During the pandemic, millions of Americans discovered that they prefer working from home and refused to return to the office. Occupancy rates for many office buildings, as a result, are now so low that cash flow doesn’t cover expenses.
The post-pandemic inflation spike forced governments to raise interest rates just as loans on thousands of office buildings are coming up for refinancing. Combine lower cash flow with higher interest expense, and the result is plummeting valuations for many office buildings.
The Trump administration begins cutting the federal workforce, further emptying already underused offices. The result: a mountain of bad commercial real estate paper festering on bank balance sheets, threatening a banking crisis in the coming year.
(Wolf Street) - Vacant office space in the US grew by an additional 8.06 million square feet (s.f.) in Q1, the 18th quarter of negative net absorption over the past 20 quarters, increasing the amount of vacant office space to a monstrous 1.1 billion s.f.
This pushed the vacancy rate to a record 22.6%, up from the 12%-13% range before the pandemic, according to JLL’s Q1 report.
The drivers behind the jump in vacancies were primarily lease terminations by the federal government and federal contractors putting leased office space on the sublease market.
The delinquency rate of office mortgages that have been securitized into commercial mortgage-backed securities (CMBS), after spiking to 11.0% in December and surpassing even the debt-meltdown during the Financial Crisis, declined to 9.8% by the end of Q1, according to data by Trepp, which tracks and analyzes CMBS. CMBS have substantial exposure to government leases that have been or could be terminated.
Now on to residential real estate, where US home prices remain close to all-time highs, far above the means of the average buyer. In other words, record unaffordability. No surprise, then, that home sales are at Great Recession lows, with no fix in sight:
(Wolf Street) - The feverishly anticipated spring selling season is starting out as a dud. Sales of existing homes – single-family houses, townhouses, condos, and co-ops – that closed in March fell by 3.1% from the already frozen volume a year ago to 315,000 deals, not seasonally adjusted, down by 31% from March 2022, which was when home sales began to plunge after prices had spiked in many markets by 50% or more in just three years, to ridiculous levels, thereby destroying demand.
Demand destruction on display: The seasonally adjusted annual rate of sales of existing homes fell by 5.9% in March from February, and by 2.4% year-over-year, to a rate of 4.02 million, the worst March since 2009, according to the National Association of Realtors today. From the Marches in prior years (historical data from YCharts):
2024: -2.4%
2023: -7.6%
2022: -29.3%
2019: -23.1%
2018: -27.0%
You’d think homebuilders would stop producing new houses in this kind of environment, but they can’t. They have crews to maintain and raw land loans to pay off, so the new houses keep coming:
(Wolf Street) - Despite huge inventories of new houses for sale, including completed houses, homebuilders have continued to build homes at an aggressive pace.
Single-family houses for sale at all stages of construction in March remained at 493,000 houses, up by 8.4% from the bloated levels a year ago, and up by 49% from March 2019. Inventories reached this level for the first time in October 2005, on the eve of the Housing Bust when oversupply and lack of demand nearly wiped out the homebuilders.
Can An Economy Grow While Its Real Estate Tanks? Nope
Housing is a lead weight, while office space is a ticking time bomb. Neither is conducive to steady 3% non-inflationary growth. They might be the first dominoes to fall, as in 2008, or they might contribute to a crisis caused by geopolitics or an equities bear market. Either way, real estate is definitely part of the “imminent recession” story.
A little honesty would go a long way in getting us through a period of extreme difficulty. Andrew Mellon served from 1920-1932 and his policies of letting the market work to sort things out which were practiced during the depression of 1920-1921 (The Forgotten Depression) and ignored from 1929-1932 treated the country to the Great Depression and a huge expansion of government.
The greatest debt/credit expansion world-wide in history is a set up for massive problems. Some are predicting that working through our problems will be substantially worse than the Great Depression.
Excellent piece John. And the office delinquency numbers don't include the empty chairs in the empty offices that were once filled with work-from-homers. Those leases are still in force and being paid. But they certainly won't be renewed at the same size when the leases are up for renewal. That's when we will see the spike in delinquencies.
A little honesty would go a long way in getting us through a period of extreme difficulty. Andrew Mellon served from 1920-1932 and his policies of letting the market work to sort things out which were practiced during the depression of 1920-1921 (The Forgotten Depression) and ignored from 1929-1932 treated the country to the Great Depression and a huge expansion of government.
The greatest debt/credit expansion world-wide in history is a set up for massive problems. Some are predicting that working through our problems will be substantially worse than the Great Depression.
Excellent piece John. And the office delinquency numbers don't include the empty chairs in the empty offices that were once filled with work-from-homers. Those leases are still in force and being paid. But they certainly won't be renewed at the same size when the leases are up for renewal. That's when we will see the spike in delinquencies.
Dr. John