This Firm Believes CRE Is Headed for a Hard Landing

Experts have spilled uncounted words on the potential of a recession and whether the Federal Reserve could help steer the economy in for a soft landing. If Stifel’s investment banking firm Keefe, Bruyette & Woods (KBW) is right, CRE overall is about to face a massive readjustment, with values down by 10% to 20% and volumes to fall by 30% to 40%.

It gets worse for office owners and investors, who had best put up their tray tables and brace themselves against the seat ahead of them, because an extremely rough landing is on its way. KBW’s estimations on office are a 30% or more drop in values with peak-to-trough declines that could top 20% to 30%. That is an average number. Some might do better, others the opposite. And the US is only 30% to 50% into the correction. For comparison, “Volumes fell 50% annually in the GFC, -10% in 2000, and -25-45% in 1991-92. Peak-to-trough, CRE values fell 40% in the GFC and 25-30% in the early 1990s.”

“We believe this is worse than consensus expectations for 5-15% declines and that we are ~75% through correction,” KBW wrote. “At-risk markets include San Francisco, New York, D.C., Seattle, Austin, Phoenix, and others that are tech or remote heavy facing elevated supply. We believe that San Francisco and New York are widely known, while some other markets we mention may be more of a ‘surprise’ to investors.”

The firm added, “With $400bn of annual loan maturities, we expect increasing credit issues as borrowers evaluate capital and lenders become defensive; our framework implies 1-3% loan losses.”

The office impact has knock-on implications for other areas. For example, the estimate expects overall 1% to 3% loan losses and that banks hold 48% of CRE debt. Loan losses for office will be worse. For 16 companies, the analysis suggests that office exposure is at least 10% of all loans each holds.

KBW found three “surprise” findings. First is how those knock-on effects will spread elsewhere. “Lease and loan maturities suggest process will be drawn out (over 2-4 years) with spill over effects into other sectors including select multifamily, retail, and even municipal budgets,” they wrote.

Second is that more than a third of CRE is held by “funds with investment management economics,” which could increase loan performance volatility that could present more loss potential.

Third, about 40% of CRE debt is floating rate. If rates rise and stay higher for a longer period, that could create additional stress.