Some conflate crises together, but there are vast differences
It’s easy for some people to conflate economic crises with each other, but what is going on in the economy today is not Great Financial Crisis part two.
“This is all very, very different from the financial crisis period,” Mike Acton (pictured), head of research and strategy of Boston-based AEW Capital Management, told Mortgage Professional America during a recent telephone interview. “I’ve been through a bunch of these cycles, and they’re all different.”
He revisited the past to describe what was going on during the Great Recession to contrast with what’s happening now in the economy.
“The financial crisis period started with a lot of operating difficulties in the properties,” he described. “There was behind-the-scenes financial pressure building – Bear Stearns blowing up and so on.”
The first domino to fall
Bear Stearns was an investment bank, securities trading and brokerage firm that collapsed in 2008, succumbing to the financial crisis and recession that had gripped the economy – the first domino to fall, as it were. The firm would run out of cash in mere weeks before agreeing to a government-backed fire sale, before being acquired by JPMorgan Case for a mere $2 a share.
Just like that, the once venerable and powerful firm ended its 85-year run after having survived both the stock market collapse in 1929 that ushed in the Great Depression and the terrorist attack of Sept. 11, 2001.
“We had a pretty meaningful recession begin in 2008 that started to put pressure on tenant ability to actually stay in business and pay rent and households to be able to service their mortgages,” said Acton. “People lost their jobs and couldn’t service their mortgages.”
Commercial real estate was not immune: “Same thing happens in commercial properties,” Acton said, “when businesses started running into financial difficulty and can’t meet their obligations. The last time around it started with operating deficiencies which caused operating default in mortgages.”
It’s a decidedly different set of circumstances today, Acton said. “That’s not the case today,” he said, but warned “it could turn into that at some point.”
For now, however, the two financial crises are quite different. “Even in the office sector where vacancies are rising and tenants are changing how they use space and all that, it hasn’t really shown up yet in net operating income for office buildings. It hasn’t shown up yet, mainly because the leases are so long. People are still under these obligations to pay the leases. Even if they’re not using the space as much, they still have to pay the rent. So, it’s not an operating problem.”
It’s a matter of maturity
What’s occurring today? “For the most part in commercial property. It’s really a loan maturity problem first and foremost – if you have a property and the loan’s coming due today,” Acton said. “Typically, with real estate, I’d go as far to say most debt in America never gets paid off. It just gets renewed; it rolls over to a new loan.”
He offered a hypothetical example to illustrate: “So you have a building today, the loan’s coming due. You have a problem, and your lender has a problem as well. One, the interest on that loan is going to be much higher – it’s probably going to be twice as much from when it was originated, depending on when it was originated. And more importantly, the values may or may not still be the same.
“So, in the case of a typical office building where the loan’s maturing, the value is probably below to where it was when the loan was originated. Maybe that loan was five years ago, very typical. So the value’s down.”
Buyers of distressed office buildings are also not immune: “You’d have to find a lender that even wants to write a loan to an office property right now,” Acton said. “But if you do find one, they’re going to want to give you a lower loan than what you had originally. Let’s make up some numbers here. Let’s say you bought an office building in 2018 worth $100 million – everyone agreed, the appraisers, the lenders, the borrower and then someone gave you a 60% loan – so $60 million in proceeds. Today, when that loan is maturing, that building might only be worth $80 million and if there’s a lender that wants to write a loan on it, maybe they only want to give you 50%. So 50% of 80% is $40 million. The loan balance is $60 million. Someone needs to make up the difference because there’s a shortfall there.”
Then, it’s time to make a decision: “The owner is going to have to decide ‘do I want to pay the loan down, $20 million, and commit to much higher interest rates? There’s equity to protect there, but it’s a really hard decision to make because that owner’s looking at the go-forward cash flows of that building and there’s much less certainty about it. It becomes a much more complicated set of decisions than it was a couple of years ago.”
Still, it’s no Great Recession.
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