Commercial real estate bubble will burst, says economist who predicted 2008 housing crisis

Even though many things have recovered and rebounded since the pandemic (think Thanksgiving trip and mass gatherings), work environments seem forever changed. The pandemic has emptied office buildings as we once knew them, and central business districts have suffered. Commercial real estate is still reeling from the massive shift toward remote or hybrid work, and a reluctance to hang on. physical properties with the ease of e-commerce. It’s a mystery: Traffic to downtown business districts has more than recovered, but people simply aren’t returning to offices.

For some time, there have been signs that commercial real estate is a bubble about to burst. WeWork’s bankruptcy filing Earlier this month, there was an $18 billion canary in the coal mine, as the fallen coworking giant immediately moved to dump dozens of leases in New York City alone. A legendary Wall Street forecaster is warning that the entire space is about to implode.

“I think the biggest bubble right now is commercial real estate,” Gary Shilling, an economist best known for correctly predicting the 2008 housing crash, said on the Investing Podcast.The Julia La Roche show” last week. “It’s not on the scale of the subprime mortgage windfall,” he said, referring to the cascade of defaults that collapsed several banks in Wall Street and caused the global financial crisis, “but I think it’s a bubble that’s starting to burst.”

Before the crash, the prophet of the housing market warned that subprime lending was likely the “biggest financial problem” in the U.S. economy, and in January 2006 he wrote an article titled “The Housing Bubble Will Likely Burst.” Shilling is now president of the financial consulting firm A. Gary Shilling & Co. Inc. and editor-in-chief of A. Gary Shilling’s point of viewa monthly newsletter that promises “comprehensive investigations into key economic indicators” and their impact on investment portfolios.

Regarding remote work, Shilling told La Roche that he got a head start on his approach to commuting, having moved his own company’s office from the “canyons of lower Manhattan” to the suburbs of New Jersey in 1990.

“I got over that travel problem many years ago,” he said. Today, there are office buildings “that are vacant, and one of the problems is that these office buildings are maturing. Mortgage lenders either don’t want to renew the loans or they want much higher interest rates.”

Offices are the biggest sign of a struggling commercial real estate market

The collapse in commercial real estate has been most evident in the office sector, with vacancy rates nearly 1.5 times higher than at the end of 2019, according to a report by the real estate company Cushman & Wakefield. And there could be as much as 1 billion square feet of unused office space in the United States by the end of the decade, according to the report. Moody’s Analytics calls the office vacancy rate of 19.2% this quarter “dangerously close” to the record vacancy rate of 19.3% in 1986 and 1991.

“While some real estate, such as shopping centers or retail, has been somewhat protected due to previous devaluations resulting from the rise of e-commerce, the office segment has been hit hard.” Allianz Commerce »wrote the economists in a report at the end of October. “Rising interest rates have made properties less attractive compared to risk-free government bonds and have also led to a significant decline in asset values.”

Other economists say these signs, along with rising delinquency rates and interest rates, indicate that a recovery in the commercial real estate market could be years away.

“It could easily take several years for the office market to stabilize,” says Stijn Van Nieuwerburgh, professor of real estate and finance at Colombia Business Schoolsaid Goldman Sachs in its report on commercial real estate risks published in October. He added that it was “a slow-motion trainwreck.”

But it’s not just the office sector that’s in trouble. “This is other commercial real estate [like] hotels and shopping centers, which have been struggling for some time,” Shilling said. The impending commercial real estate crash is just one sign of a struggling economy. Shilling also predicts that the S&P could fall to its lowest level since the pandemic – and that “we’ll probably have a recession soon, if we’re not there already – no one’s ringing the bell.”

“I thought stocks would be down about 30 to 40 percent, peak to trough,” he said on the podcast. “If you look at many of the leading indicators that are reliable precursors to recessions, when you look at that combination of factors, it’s quite difficult to escape a recession.”

Erin Sykes, chief economist at a residential real estate brokerage International nest findersechoes Shilling’s sentiments on the real estate market, saying commercial spaces have struggled to pay their rent on time.

“Shopping centers and underutilized retail spaces are at the forefront of delinquencies,” she explains. Fortune. “Remember that real estate is local, even if large cities experience a difficult commercial landscape.”

Delinquency rates for commercial mortgages have been rising for four straight quarters, which include office, multifamily and other commercial properties, according to the Mortgage Bankers Association (MBA). More than 5% of office real estate loans were delinquent in the third quarter, and an additional 5% of retail loan balances were delinquent.

“Commercial real estate markets face challenges related to uncertainty over the fundamentals of some properties, lack of transparency on current property values ​​and higher and volatile interest rates,” said Jamie Woodwell, head of commercial real estate research at the MBA, in a statement. statement. “The result has been a slow and steady rise in delinquency rates, concentrated on loans facing more of these challenges. »

Although Shilling did not define exactly when the bubble would burst, others believe it could be sooner than expected.

“It’s very possible that this is already happening,” Sykes says.

And real estate mogul Jeff Greene, who bet against the mid-2000s housing bubble and grossed about $800 million, said in September that we’re right in the first steps of a commercial real estate correction.

“I think we are only in the first round of this correction,” Greene told CNBC. “I hate saying that.”

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