Financial Sugar Crash

This past weekend was a long one for holiday events. Not only did we have Easter, but Ramadan and Passover in the same week. Regardless of your celebration, you may have experienced a bit of sugar shock over the weekend. I know these three did. Don't let this placid visage fool you though, it only lasted a car ride before the sugar campaign continued. However at some point there comes the time to brush teeth. Let's see if I can spin this into a real estate metaphor?!

 

Just like the sugar rush of 2020 to 2021, there is life after the party. Austin still remains a great city to own real estate in. You might see some headlines about Austin being the most overbought market in the US. That might actually be true, but after a 40%+ run up in prices in two years what else would you expect?

 

Prices (in residential real estate) have come down by as much as 15% depending on what price point and sub market you examine. However in the worst case over two years you are still up 25%. So it doesn't suck to bad. Fundamentally the desirability of the city remains strong. Businesses are still here, albeit some with fewer employees for now, the city continues to grow, houses are still being built, and people are still buying property and building lives here. Overall employment is still low by the way, many of those laid off from the big tech firms are finding work at other companies successfully.

 

I would be more concerned if more people were leaving the city than are moving in. So far that isn't happening. I might even be more concerned if I could get a building permit in a reasonable amount of time which would enable the construction of more housing. Alas that still isn't happening. So we are still in for a short housing supply for the immediate future. That being said we are now up to a whopping 2.6 months of inventory which still isn't a lot. That also isn't from more listings, but rather fewer buyers. As of this writing, there are only 2710 active listings in all of Austin. If that got close to 5,000 we would be back in 2010.

 

Well if you remember the last newsletter I said to watch for the Fed meeting on March 23rd. They did go ahead and raise rates by 0.25% which is less than last time, but it wasn't the pause some people were hoping for. The Fed seems even more committed to fighting inflation than showing any relief on interest rates at this time.

 

In the last month no significant banks failed outside of SVB, so perhaps is really is just one bank that took its eye off the ball and hoped beyond all reason that things would turn around and when they simply didn't they fell over. I am certainly glad to see that for now, it appears to be an isolated case, but I wouldn't go so far as to say we are clear of the potential problem.

 

What you may not be paying attention to is the coming crisis in commercial loans. Well, why should I care about that as a homeowner? Maybe you shouldn't, but you've read this far so I'm just going to tell you and we'll see how it goes.

 

Commercial loans are typically 10-25-year loans, some are shorter but rarely. When they expire, they are typically renewed or an owner will sell an asset depending on what their goals are. Either way, new debt gets written. Now rates have gone up which makes it harder to finance commercial real estate, but in a normal world, time is on your side, your equity in the asset grows as well as rents so refinancing new debt is not usually a big deal and often comes with a payday for the owners.

 

This time around, we had the pandemic in the middle of that debt cycle which we have largely recovered from, however the one thing it did that no one could have predicted was drastically reduce the number of people going into an office. Office buildings with expiring debt are going to be in extra trouble because rates will be much higher and rents will be lower to the extent that many loans will be foreclosed on. Banks will fire-sale these commercial buildings, but no one will want to buy them because there isn't enough demand for office space in a post-pandemic work world.

 

A little Google searching and you will see the number 2 Trillion in commercial debt is expiring in 2023 which is held by banks. For scale, the current US M2 Money supply is around 19 Trillion. Now that is all commercial debt, which includes industrial, multi-family, and a bunch of other assets, so some subset of that is for office space.

 

Once these loans expire, we will see more distressed office space and retail assets for sure. Lenders are also not likely to write new loans on these distressed assets even if there are new buyers. Some will work for sure, but banks will be more hesitant.

 

This risk could push over some banks that are more exposed to these types of loans. The question remains how much exposure there is, who it will knock out, and whether or not the government will feel compelled to bail out any fallen dominoes. This should all play out through the rest of the year.

 

The government could buy these distressed loans which would be inflationary, Lord Powel will be displeased.

 

The government could mandate that people go back to work in offices. This is kind of extreme, and I don't think it's likely, but it would push artificial demand for this asset class which could prop it back up. I can see the pitchforks being polished in this scenario.

 

Falling prices on commercial real estate mean falling tax revenues as well as lower returns for pension funds that own a lot of these things. That could shift tax collectors to get more revenue from single-family, multi-family, and industrial assets. Property taxes in those sectors could go up which would also be inflationary and sucky for those owners and their tenants.

 

Then again none of those things could happen too. It is something I find fascinating and enjoy sharing with you.

 

As always, question everything, and don't take suggestions as absolutes. These are written from a perspective of our experience and offer our insight however limited. We're not perfect and get things wrong, but not on purpose.