This Exec Thinks It’s a Long Way to Bottom

There’s a practical chorus of big investors and experts saying that commercial real estate, excepting maybe office, is getting closer to bottom if not there already.

But not everyone.

Drew McKnight, Fortress Investment Group co-CEO & managing partner, was far more cautious in a recent CNBC interview. “I think it’s top of the first inning. If you look at the number of defaults today, it’s very, very low,” he said, pointing to a number of reasons.

One is extension of maturities by lenders who don’t want impaired assets to sit on their balance sheets. But further, he said that “capital structures are upside down,” and not just in office but also multifamily.

“Real estate was the biggest beneficiary of low rates,” he added. “And unless rates can reset and reset quickly, I just don’t see an easy solution.” He pointed to the Resolution Trust Corporation (RTC) and the infamous S&L crisis.

Owned by the federal government, the RTC was created in 1989 to liquidate assets — mostly real estate loans made as part of the savings and loan associations crash earlier in the decade. From then to 1995, it closed 747 S&Ls with assets over $407 billion, according to the Federal Reserve.

During the Global Financial Crisis, the number of problem banks — those deemed on the brink of insolvency though not necessarily closed — rose to almost 900, or 12% of all FDIC-insured institutions, as the Federal Deposit Insurance Corporation has said. There were ultimately 489 bank failures between 2008 and 2013.

“We’ve had five [bank failures] so far,” McKnight said. “I’m not saying we’re going to have that deep of a recession, but if you think about RTC, it was very centralized to real estate. Our own view is that the economy might be able to hold up okay even if we have this real estate reset. But for folks that own real estate levered, it could be very painful.”

The considerations are different for giant investors. When asked about remarks by John Gray, chief executive officer and president of Blackstone Group who believes the market has bottomed out, he said, “I think they have a very large and long time horizon, and so in the context of trying to put a hundred million dollars to work, maybe you need to get really aggressive right now. In the context of trying to pick a bottom, I think it’s really, really early. I think we have a lot of time. I think prices will go lower for real estate, almost across the board.”

Calling a bottom on a real estate market is difficult. In October 2023, some were saying that multifamily had bottomed out, but clearly that isn’t the case.