Last week, WeWork filed for bankruptcy and shook the Commercial Real Estate (CRE) sector at its seams. The company revolutionized the industry in 2010 with a simple business model: Lease office spaces from landlords at discounted rents, then beautify the areas up with ergonomically designed workstations and re-rent them to customers on a permanent or temporary basis at a markup.
We warned our readers eight months ago in our editorial about the impending crisis in the industry: Commercial Real Estate Struggles As Work-From-Home And High-Interest Rates Take A Toll
The commercial real estate industry – offices, industrial, retail (malls), and multifamily housing (apartments) – is facing two unprecedented structural challenges, both of which show no signs of easing. WeWork is a symptom of these challenges.
Covid. First, when Covid attacked with a vengeance, the CRE sector took a direct hit. Lockdowns meant that staff worked from home. The allure of downtowns fell as workers stopped visiting restaurants and eateries they had often flocked to during lunch and after work.
As Covid eased, companies perfected the hybrid model, with most employees working from home a few days a week. Companies began resorting to the so-called “hoteling” system. If employees wanted to work in the office, they had to “reserve” a working space that would expire at the end of the day. According to the Census Bureau’s Household Pulse Survey, 29% of Americans reported at least one person in the household working remotely for at least one day a week between September 20 and October 2.
By rotating workers through the week, companies could slash real estate needs by 40% to 50% and return those spaces to landlords. Landlords, in turn, have been struggling to lease out empty spaces as there aren’t as many takers. Empty offices mean no rental revenue, but landlords still have to make loan payments to banks.
Interest rate increases. Second, the Fed has been raising interest rates steadily, from near zero in April 2022 to more than 5.25%, and holding it steady at the latest FOMC meeting. When a landlord approaches his bank to refinance his loan, he must pay a significantly higher interest rate, upwards of 6%, compared to the 1% he did during the golden years. With the asset’s underlying value having fallen, the bank also warns him that the collateral value of the building no longer covers the loan’s value, so could the borrower cover the margin? That is, pay up the difference? From where does the landlord get the funds to do this?
WeWork’s troubles significantly magnify the CRE sector’s troubles because of WeWork’s size. In the US and Canada alone, WeWork had leased 18 million square feet of office space at the end of 2022. In an August 8 SEC filing, WeWork said, “Our losses and negative cash flows from operating activities raise substantial doubt about our ability to continue as a going concern.” With the bankruptcy, WeWork’s unused leased spaces will be released to a market when no one wants to lease. Excess supply and low demand create highly unfavorable conditions, as every high school economics student knows.
These unfavorable conditions are already crippling several other real estate players. Yesterday’s Wall Street Journal reported a shocking story about increasing foreclosures on mezzanine loans. Many real estate companies do not want to put down a large downpayment when they finance a building’s acquisition and borrow that from a different lender (generally a rural bank or a hedge fund) – meaning they have two lenders servicing their debt.
When a building’s asset value falls, borrowers stop making payments as their properties are “underwater,” a hopeless situation millions of homeowners found themselves in during the 2008 financial crisis. That is when banks foreclose on properties and attempt to recover whatever equity in the building still remains.
A New York Times story two weeks ago illustrates the above situation with a real-world situation. A New York landlord took out a $77 million loan on a building worth $127 million, posting the value of the building as collateral. But confronted with no rental income as vacancies shot up to 90%, the landlord stopped making loan payments to his bank’s servicer, which revalued the building at just $42 million. That servicer is now moving to foreclose the property. (The story did not indicate that a mezzanine loan was involved.)
Foreclosures are terrible for the real estate industry. Everyone loses, including the banks. According to Moody’s Analytics, the total outstanding CRE debt market is $4.5 trillion. Banks account for 38.6% of this lending, nearly $1.7 trillion. If you’re a rural or community bank, and you are forced to foreclose because your borrower defaulted, the bank could be at risk and may need a bailout.
It’s a double whammy situation for the banks, which must also contend with “duration risk.” As we noted in March, Silicon Valley Bank largely failed because it had large deposits of Treasury Securities that lost value when the Fed raised rates. Bond prices move in an opposite direction compared to interest rates.
You may ask, “Why are interest rates so high?” Well, elections have consequences, and you can trace many of the nation’s problems back to President Biden’s policies. Biden’s spending fueled inflation, which peaked at 9.1% in June 2022. In an effort to control inflation, the Federal Reserve had to raise interest rates. However, while the Fed is increasing rates to combat inflation, Biden continues to boost spending, further stoking inflation. It’s like Biden’s policies are the wind fanning the flames while the Fed, acting as the firefighter, struggles to extinguish the fire. The end result is prolonged stagflation.
Due to these high interest rates, Americans are now paying 11.4% for used car loans and 7.8% for mortgages. Under Biden, for most Americans, buying a new car has become unaffordable, and owning a new home is an unattainable dream. Tell that to Janet Yellen, the modern-day Nero, who will tell you how well we are prospering because of Bidenomics.
It’s not a good time to be in the CRE sector. As is often the case, troubles in this sector tend to trickle down to residential real estate and the overall banking sector. In April, Elon Musk warned of another Great Depression. We wonder if the country is ready for this.
TIPP Takes
Geopolitics And Geoeconomics
1. Hamas Says Ready To Release 70 Hostages In Return For 5-Day Truce – Reuters
Abu Ubaida, spokesman for the armed wing of Hamas, Al Qassam Brigades, said the truce should include a complete ceasefire allowing aid and humanitarian relief everywhere in the Gaza Strip.
He went on to accuse Israel of “procrastinating and evading” the price of the deal.
2. Israel’s President Denies It Is Striking Gaza’s Al-Shifa Hospital – BBC
Israeli President Isaac Herzog has denied that Israel is striking the Al-Shifa Hospital, the largest hospital in the Gaza Strip.
Doctors there have said newborn babies have died after power for incubators was cut off due to a lack of fuel. When challenged by the BBC’s Laura Kuenssberg about those reports, Mr Herzog rejected them as “spin by Hamas” and insisted there was electricity.
3. WHO Says Gaza’s Biggest Hospital Becoming A Cemetery – BBC
Gaza’s biggest hospital, Al-Shifa, is “nearly a cemetery,” the World Health Organization warns, with bodies piling up inside and outside.
Fighting has been raging close to the hospital in Gaza City in recent days, with severe fuel shortages affecting treatment. Israel has accused Hamas of having a command and control center under the hospital – which the facility and Hamas deny.
4. Arab-Islamic Summit Rejects Describing Or Justifying Gaza War As ‘Self-Defense’ – Al Arabiya
An Arab-Islamic summit hosted by Saudi Arabia condemned “Israeli aggression on the Gaza Strip, war crimes and barbaric and inhumane massacres by the occupation government,” a final communique said.
While calling for an end to the siege on Gaza, Arab and Muslim leaders also said they rejected any proposal that would keep Gaza separate from the West Bank in a future Palestinian state as Israel pressed its war against Hamas in Gaza.
5. Brazil’s President Says Israel Response ‘As Grave’ As Hamas Attack – AFP
“After the act of terrorism provoked by Hamas, the consequences, the solution of the state of Israel, is as grave as that of Hamas. They are killing innocent people without any criteria,” said Luiz Inacio Lula da Silva at an official ceremony in Brasilia.
Representatives of Brazil’s Jewish community denounced these remarks as “erroneous,” “unfair,” and “dangerous,” adding that they “put Israel and Hamas on the same level.”
6. Russia ‘Alarmed’ By Reports Of Ukraine’s Role In Nord Stream Attack – Al Jazeera
The Kremlin has expressed “alarm” over a report that senior Ukrainian military officials, acting without their president’s knowledge, coordinated an attack on Russia’s Nord Stream gas pipelines last year.
A spokesman for Russian President Vladimir Putin said that the report, published by The Washington Post, is further evidence of Ukrainian involvement in the attack. The West should also be concerned over the claim that Ukrainian President Volodymyr Zelenskyy was unaware of the operation.
7. Zelenskyy Warns Russian Attacks On Infra This Winter – AFP
Ukrainian President Volodymyr Zelenskyy said that Ukraine should get ready for winter, fearing that Russia would renew its campaign of systematic strikes on power facilities.
Repeated attacks by Moscow’s forces last year targeted Ukraine’s energy grid, leaving thousands without heating or electricity in freezing temperatures for long periods.
“The Ukrainian air shield is already stronger than last year,” Zelenskyy said. Ukraine has received significant air defense systems from the West, including the United States-made Patriot.
8. Xi, Biden To Talk ‘Global Peace, Development’ At Summit – China – AFP
“The two heads of state will have in-depth communication on strategic, general, and directional issues concerning China-U.S. relations, as well as major issues concerning global peace and development,” Beijing’s Foreign Ministry spokesman Mao Ning said.
“China is not afraid of competition, but we oppose defining the China-U.S. relationship in terms of competition,” she added.
Biden and Xi will meet on the sidelines of the Asia-Pacific Economic Cooperation summit in San Francisco.
9. China Calls On Businesses To Join Hands With State Sector – RFA
China’s ruling Communist Party calls on the country’s businesses to invest in infrastructure projects to stimulate domestic demand and reboot the flagging economy. Still, analysts said the plan looks like an attempt to seize private sector assets as governments run out of money across the country.
Under the plan, the government will allocate “franchises” to invest in infrastructure projects on a “user pays” or “build-operate-transfer” basis, according to an official statement.
10. China’s Probe Into Foxconn ‘Political,’ Taiwan Security Chief Says – Al Jazeera
Taipei’s national security chief has said a Chinese tax probe into Taiwan tech giant Foxconn is “political” as its billionaire founder, Terry Gou, is running for president of the democratically ruled island.
Gou, who gave up Foxconn’s management reins four years ago, launched his presidential bid in August as an independent candidate in Taiwan’s January polls.
11. China’s Chipmaking Equipment Imports Surge 93% Despite Curbs – Nikkei Asia
Chinese imports of semiconductor manufacturing equipment rose more than 90% last quarter, as the country has proven able to produce advanced chips despite trade controls imposed by the U.S. and its allies.
Imports of machinery and equipment for producing semiconductors or integrated circuits jumped 93% in the three months through September to 63.4 billion yuan ($8.7 billion), analysis of Chinese customs data shows.
12. Nepal Bans TikTok Citing Disruption To Social Harmony – BBC
The decision comes days after the country introduced a new rule requiring social media firms to set up liaison offices in the country.
TikTok, which has around a billion monthly users, has been banned by several countries, including India. TikTok has come under scrutiny from authorities worldwide over concerns that data could be passed to the Chinese government.
13. Chinese Firms Operated 38 Fake News Websites In S. Korea: NIS – Yonhap
Two Chinese public relations companies – Haimai and Haixun – have created fake Korean news websites, posting articles from local news outlets without consent and posing as members of the Korea Digital News Association, according to South Korea’s spy agency, National Intelligence Service (NIS).
The NIS said it would shut down the fake news sites in cooperation with other related government agencies and keep a close watch on China’s activities aimed at expanding its cyber influence in South Korea.
14. Former PM Cameron Makes Shock Return To UK Government As Foreign Minister – AFP & Bloomberg
Former UK leader David Cameron sensationally returned to the British government as foreign secretary. Prime Minister Rishi Sunak shook up his top team ahead of a general election expected next year.
Sunak sacked right-wing firebrand Suella Braverman as interior minister after critics accused her of heightening tensions during weeks of contentious pro-Palestinian demonstrations and counter-protests in Britain.
He replaced her with James Cleverly, who had been foreign secretary, before announcing Cameron as Cleverly’s surprise replacement.
15. U.S. Forces In Syria Targeted Four Times In Less Than 24 Hours, Military Official – Reuters
U.S. and international forces in northeastern Syria were attacked with drones and rockets at least four times in the past 24 hours. However, a U.S. military official said there were no casualties and only minor damage.
The attacks came after the U.S. carried out two airstrikes on Sunday against facilities it said were used by Iran-aligned groups, its third set of strikes in Syria in as many weeks.
16. Australian Who Blew Whistle On Alleged Afghan War Crimes Stands Trial – Al Jazeera
David McBride, a former army lawyer who revealed information about alleged Australian war crimes in Afghanistan, could be facing a “life sentence” if found guilty in a trial that started Monday.
McBride is open about the fact he leaked documents to the ABC, Australia’s public broadcaster, leading to a series of articles called the Afghan Files. Although McBride sees the information he revealed as being in the public interest, his ability to claim a whistleblowing defense has been limited by claims of national security.
17. S. Korea, U.S. Revise ‘Tailored Deterrence Strategy’ On N. Korea – Yonhap
The 2023 Tailored Deterrence Strategy (TDS), revised for the first time in 10 years, underscores the U.S. “extended deterrence” commitment to defend South Korea by using all of its nuclear and other military capabilities in the face of a nuclear-armed North Korea.
South Korean Defense Minister Shin Won-sik and U.S. Defense Secretary Lloyd Austin adopted the document during the 55th session of Seoul’s annual Security Consultative Meeting.
18. 80 Freed From Migrant Centers In Australia – A.P.
Dozens of people, including convicted criminals who are considered dangerous, have been released from migrant detention centers in Australia since the island continent’s High Court ruled that their indefinite detention was unconstitutional.
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Republished with permission from TIPP Insights
