What Commercial Real Estate Stress Means for Banks and Bond Funds

Joe Weisenthal (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Joe Weisenthal.

Tracy Alloway (0:15)

And I'm Tracy Alloway.

Joe Weisenthal (0:17)

Tracy, there's two things that people, there's all kinds of things people are very attuned to these days, but I would say, what's going on with regional banks has obviously become a huge focus, with the collapse of Silicon Valley Bank, and then what is going on with commercial real estate. And we talked about that recently, and everyone knows the office woes that are hitting major cities like New York, two things that are top of mind for many people.

Tracy Alloway (0:44)

Well, and I think they started out separate to each other, because there were concerns about commercial real estate even before Silicon Valley Bank went bust. But since then, and since we've had the turmoil in the banking sector, the deposit flight, there is a concern that that is going to also start affecting the CRE outlook. And basically, these two things are impacting each other and compounding each other at the same time, because of course, regional banks have quite substantial exposure to commercial real estate.

Joe Weisenthal (1:18)

Right, so that was the interesting thing about SVB specifically, which is that there seem to be many problems there. But one thing it was not, it did not really seem to be about the credit quality of the assets. It was a rate story, it was a deposit concentration story, but it wasn't about, oh, they have some sort of asset side exposure to something that's troubled.

But then, as you point out correctly, in the immediate wake, a bunch of people sort of stuck up their fingers like, oh, by the way, guys, these regional banks are worried about, they also are sort of disproportionately the funders of commercial real estate.

Tracy Alloway (1:52)

This is it. So there's two things here. So one, there's concern about the commercial real estate loans that some of these smaller regional banks might hold. Are those actually going to default? Are they going to come distressed in some way?

Are they going to be able to refinance them in the current environment?

And then secondly, as you get the stress in the banking system, as you see deposits pulled from smaller banks, are they still going to be able to pour money into that sector? And those two things are sort of impacting each other.

Joe Weisenthal (2:22)

They go in both directions as you sort of clarify there. And I think the other thing too is like, you know, people like doom.

I mean, I don't, but you know what I'm saying? Like people are still like, this is the exact type of thing that gets people going. And people post all these charts that most people, you know, like don't, aren't really equipped to understand, including myself. Like I don't really, you know, I'm a novice on this stuff.

And so I think it's kind of important to like, let's sort of get real. Let's put some numbers and like, how big of a deal is this? Because there is a lot of like, oh, you know, people that have these fantasies of 2008 and they're having stuff like that.

Tracy Alloway (2:57)

I think people here, this is a $20 trillion market and they think, oh, this is a very big deal. But of course, as we spoke about in a relatively recent episode with Rich Hill, it's not a monolithic market and a multifamily, you know, residential development is different to an office building in downtown New York that might be empty now. And also, you know, a big bank is going to have a different risk profile to the sector than a smaller regional bank. So it's important to dive into the details.

Joe Weisenthal (3:27)

Yeah, totally. And, you know, there's office, which we all know, because you could just pull up like a chart of like a big office rate, like a Vornado or something. And then there's medical, which is probably fine. And there's all these different categories. So we really need to, given the interest, we really need to dive sort of like deeper into like, all right, let's talk about some of these exposures. Let's talk about these relationships. Let's get some like real numbers rather than just sort of like...

Tracy Alloway (3:50)

Let's get granular, baby.

Joe Weisenthal (3:52)

Let's get granular.

All right, well, we have the perfect guest to speak about this.

We're gonna be speaking to Jim Costello, Chief Economist over at MSCI's Real Assets Team. He was recommended to us by our recent guest, Ben Carlos Taipin. He said, this is the guy you wanna talk about. That was a really good episode on New York City Residential.