By John B. Levy, a former monthly Barron's columnist for over 23 years
Commercial real estate types haven’t been having a swell time these days – to virtually no one’s surprise. The market is choppy, to say the least. But that doesn’t mean there aren’t opportunities. As the late speaker-of-the-house – Tip O’Neill – would say, “All politics is local.” But for sure, so is all real estate. Office buildings in New York, Boston, and San Francisco are clearly getting battered. But that’s not the case everywhere. Take a look at Dallas, Miami, and Palm Beach, just to name a few, and you’ll see a much different story.
Lending volume for institutional first mortgages as issued by life insurance companies and pension funds, is dramatically lower, even more than one might expect. For example, in January and February 2023, loan origination volume was running less than one-third of the amounts seen in 2019, 2020, and 2021. And that’s not taking into account the loan volume in 2022, which was a huge blowout.
Looking at the primary asset classes, office building originations are in a funk, but for those in the industrial sector, things feel a lot better, even after Amazon and other tech giants have decided to cut back on their leasing and building of new warehouses.
With no intent to be a downer, delinquencies are headed exactly where you might expect – up. And that’s true for both first mortgages, as measured by the G-L 1, and high-yield investments, as measured by our proprietary G-L 2 high-yield index. Delinquency rates for both have TRIPLED over the past year but still remain at relatively modest levels. To be sure, given the volatility in the market, we expect those numbers to increase again in 2023.
We don’t know how the high-yield investment market will fare once the current gyrations are over, but we do have a few ideas on the severity of potential losses based on how the global financial crisis of 2008-2009 turned out. Using our updated numbers, we would expect potential loss exposure of slightly less than 12% in the G-L 2 index, assuming that there was to be a 30% decline in property value this time around, which matches the decline of the GFC. To be sure, that number, though painful, seems relatively modest and reflects loans that were more conservatively leveraged than last time.
As always, we welcome and look forward to your comments and suggestions.
