Where Stress Is Showing in the $20 Trillion Commercial Real Estate Market

Tracy Alloway (0:09)

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

Joe Weisenthal (0:14)

And I'm Joe Weisenthal.

Tracy Alloway (0:15)

Joe, people have been asking for this episode for a long time.

Joe Weisenthal (0:18)

Yeah, there's a lot going on right now, definitely. A lot of balls in the air.

But there is one topic, one particular topic that's been brewing for a while as a source of concern, is what's gonna happen with commercial real estate, particularly office buildings.

Tracy Alloway (0:35)

That's right. So we recently had the collapse of Silicon Valley Bank, and that set off a little bit of a banking crisis.

But a lot of people are talking about the next shoe to drop, really being on the property or the real estate side. And obviously there's been a lot of concern about what exactly is going on with office buildings. But just interest rates going up in general tends to be bad for real estate as a broader category. So I think this is something that we really need to dig into.

Joe Weisenthal (1:08)

Yeah, I mean, right. So obviously real estate, my understanding is that it's a highly leveraged industry in almost any factor, whether it's malls or office buildings or apartments or single family homes, there's a lot of borrowing. Ergo, I think rates matter. And like every other industry, it's dealing with this reversal of a long downtrend. And then with office rates in particular, we all know that working from home is still a thing. Not everyone goes to the office every day like they were.

And so companies are reducing footprints. And so if you are the owner of commercial property, you may be looking at a double whammy in which, A, your loan is set to reset or your commercial mortgage that you plan to roll over is set to reset.

And at the same time, because of vacancies, your business is not as good as maybe it was in 2019 So potentially a major stress point emerging for a lot of players.

Tracy Alloway (2:02)

And the other thing I would say is, even without the pandemic and even without the work from home trend, there was concern about excess in commercial real estate or CRE, even prior to 2020 I remember when I was at the Financial Times, I was writing a lot about the bond market and credit markets.

And I used to write a lot of stories about subpar underwriting in commercial mortgage-backed securities.

And investors really reaching for yield in that sector. And there was one person I spoke to quite a lot when I was doing those stories. And so I am very pleased to say that we do have the perfect guest for this episode. We are going to be speaking to Rich Hill. I knew him when he was an analyst at Morgan Stanley, but he is now over at Cohen & Steers as head of real estate strategy and research. So Rich, thank you so much for coming on Odd Lots.

Rich Hill (2:59)

Yeah, thanks so much for having me.

Tracy Alloway (3:01)

So maybe just to begin with, you know, Joe kind of alluded to this in the intro, but commercial real estate, it's not a monolith. There are a lot of different subsectors within that broad category, and there are a lot of different actors, so lenders, investors, things like that.

Can you talk to us a little bit about the ecosystem? What does the ecosystem of CRE actually look like?

Rich Hill (3:25)

Yeah, it's a great question. Look, I actually don't disagree with anything you said in your remarks to start this, but maybe we'll just start off by talking about the size of the commercial real estate market.

We estimate it's around a $20 trillion market. That's a pretty big market.

And if you think about commercial real estate, everyone thinks about it as a singular asset class, but it's really 15 different property types under one umbrella.

And in many cases, those 15 different property types are sometimes like my kindergartner. They move to one side of the room and then the other side of the room. The fundamentals don't necessarily all act the same. So you have office.

Tracy Alloway (4:02)

Are they fun of it or is there a reason?

Rich Hill (4:05)

Why the fundamentals don't move in the same direction?

Tracy Alloway (4:08)

Why people move around so much.

Rich Hill (4:10)

Yeah, well, you know, what I would just, the point I'm trying to make here is that, you know, you have office, you have retail, you have multifamily. What drives multifamily fundamentals might be much different than what drives retail fundamentals. And we haven't even really started talking about some of the sub-sectors like healthcare, for instance, or data centers, or cell towers.