CJ Doherty: Welcome to the Lending Lowdown. I'm CJ Doherty, director of analysis here at LSEG LPC. And today we're pivoting to another part of the lending market, the commercial property market, which has been grabbing headlines and raising concerns among policymakers and investors. And most recently, Berkshire Hathaway Vice Chair Charlie Munger issued a warning about the US commercial property market, saying banks were full of bad loans. Overall, the market is roughly 5.5 trillion in size, so very significant. And the environment has changed with less demand for office space, given more work from home these days. And higher interest rates is also among the factors impacting the market. So it's something we want to delve more into. And to do that, I'm happy to be joined by Richard Leong, Senior Reporter at our sister company, IFR. Welcome Richard. Thanks for joining me. Great.
Richard Leong: Thank you for having me CJ.
CJ Doherty: Great. So to kick it off then, Richard, Let's start broadly. And can you set the stage and talk about the challenges that the commercial real estate market is facing.
Richard Leong: There is quite a few. First of all, you have the biggest increase in interest rates here in the US in 40 years, then you're seeing property prices for roughly about 20 percent. But the fear is that they're going to drop even more over the course of the next 12 to 18 months. And thirdly, and probably the most uncertain risk that the market is facing, it's about remote work. We just don't know right now how this is going to impact long-term demand for office space here in the US and even around the world.
CJ Doherty: Okay, great. And to what degree have these pressures intensified after the collapse of Silicon Valley Bank, Signature Bank, and First Republic. How exposed are banks?
Richard Leong: So let me just be clear that the collapse of those banks had nothing to do with commercial real estate. They had to do with deposit wounds because of their customer base and losses on investment because of the huge jump in interest rates. But it is a leading the market to speculate whether the losses from banks’ exposure to commercial real estate, especially regional ones are, and whether commercial roof state is really the next big shoe to drop for the market and for the banking system. So overall banks have a pretty wide range of commercial real estate exposure. You have some that have very little to ones that have as much as 20 to 30% depending on the size, which is quite sizable. And that's what's causing concerns in the market right now.
CJ Doherty: Okay. And so against this backdrop that you've described, to what extent are lending standards, tightening and bags pulling back? If we look at some definitive data, US CMBS issuance slowed to roughly 14 billion in the first quarter of this year, and that was actually the lowest quarterly volume since 2012.
Richard Leong: That drop in volume is a reflection of what we're seeing in the tightening of lending standards. Banks, so essentially demanding more cash from, from the borrowers. Also, for the banks to demand a higher compensation for the loans that they are making. Borrowers themselves are quite reluctant at this point. Some of them to make that commitment because they just don't know whether the properties that they own right now, it's gonna be worth anywhere near the price that they paid for it just several years ago.
CJ Doherty: Okay. So given what you've kinda described there, I'd like to delve a little bit more into the level of pressure in the market these days. What are you seeing in terms of delinquencies and to what extent have we seen downgrades and CMBS recently? And to what extent are downgrade set to continue?
Richard Leong: Delinquency levels are definitely on the rise. But on historical basis this is still very low. Even a problem set them like office right now, it's still fairly low based on the recent data from different firms, they're roughly about two per cent which uninstall gold level, there's still quite low. But again, the mortgage looking at the trajectory of these delinquencies. And you're seeing some of the rating agencies responding by putting some of these deals on what they call watch. So they are up there for password downgrades. And the expectation is that a lot more of these details might be on a watch list for possible downgrades.
CJ Doherty: Okay, definitely worth keeping, keeping monitoring that. And I want to stay on the topic of stress in the market. There have been some major defaults in the commercial real estate sector in the past year. Can you provide some names and context here?
Richard Leong: I think two of the biggest name that have really grabbed the attention of the market. Or two of the biggest private equity funds in the world, which are Blackstone and Brookfield. Plaques don't in particular here in Manhattan, for instance, where I work, they default on the loan on a big, big Chairman hand office buildings. So desk started grabbing the markets attention. And Brookfield this year have defaulted on a couple of office property in LA and that's also causing quite a bit of a stir and concern in the market that you have big deep pocket investor that have a lot of money into this sector and now they are just defaulting on their loans.
CJ Doherty: Okay, great. So a lot of the information you've provided here today, we've touched on a lot of the negativity around the commercial real estate market recently. But before we wrap up, I want to get your opinion on whether you see opportunities in this environment too.
Richard Leong: I think that definitely one sector of the investment community that are looking at bargain hunting, looking at whether these properties, once they become distressed and perhaps are they have to be offloaded through some kind of event via cell, whether they could pick up these properties at a bargain price in hopes that they can work out their problems with tenants, or the fact that essentially they could ride out the real estate and interests rates cycle that we're in right now and the property values are going to go up and they could profit from it. So that's definitely one of the area in which some part of the investor community is looking at to maybe make some money off from the downturn that we've seen, all the stress that we're seeing in the market.
CJ Doherty: Okay, great Richard. And on that note, we'll wrap up for today and we will certainly be keeping a close eye on the commercial property market in the coming months to see how things play out. Richard, Thanks very much for sharing your insights with us and thank you all for tuning in. I invite you to check out IFRS coverage on the commercial property market and indeed the broader capital markets at ifre.com and follow them on Twitter at IFR tweets. I'm CJ Doherty. Subscribe to the Lending Lowdown on your favorite podcast platform.
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