Commercial Real Estate ... Dead Lock for Private Equity Funds

 The aggressive rate hike consequences have been witnessed but we are yet to witness a major setback across the globe where MSMEs and start-ups will bleed further. In this story, we are digging behind the rationales which germinate the crisis in the coming days.

  Mortgage Applications to buy a House just dropped 39% YoY in March. That was the worst March performance since 1995. The slowdown in the US economy is now becoming very prominent. Prices and rates are still too high. Buyers can't afford it. Check out Austin, TX for instance. Monthly House Payment for a new buyer of $3,600 compared to $1,800 two years ago.  Well, you may not face 2008 but are you ready to face any slightest of the same is the biggest question of today?

The private equity space is becoming more of a pain due to the rising interest rates and asset-class investments they have made over the last couple of years.

143 US companies filed for bankruptcy protection in the first 75 days of the year, including 16 companies with private equity or venture capital backing, according to an S&P Global Market Intelligence analysis.

If we look at history we find that the housing industry's collapse was mainly due to continuous increases in interest rates when buyers left the market. Rest of the history we know. This time buyers are again leaving the industry simultaneously the workers are losing jobs and becoming unemployed. Commercial real estate projects have been a nightmare due to rising interest rates making it difficult to fund conversion projects.

Many city projects are awaiting for major fall back likewise Vancouver’s where the vacancy rate is at 9.8 percent in the fourth quarter of last year – slightly below the 2017 vacancy-rate peak of about 10 percent, which at the time was a 12-year high. Manhattan’s overall vacancy Close to 19% of all high-end office space available for lease in the fourth quarter of 2022, according to brokerage Savills, up from 11.5% in early 2019.  On the other hand San Francisco’s office vacancy rate shot up to a record high of 29.4% in the first quarter, nearly eight times the pre-pandemic level.

 The value of the property is falling at the same time the investment market is plummeting when the asset class is compared to rising yields on bonds and other securities. The risk is growing bigger every day for the commercial real estate sector. It has been found that office defaults increase as more mortgages that were signed before the pandemic expire. Around $2.6 trillion in commercial mortgages are set to mature between 2023 and 2027.

Now we need to know the depth of the mortgage the bank holds and the depositor’s money parked with the bank. During the pandemic, the stimulus package of the US resulted in an accumulation of $2.3 trillion in so-called excess savings which were parked with banks as that was the best product to earn yields. Now banks further deployed deposits and invested in mortgage-backed securities valued at $2.8 trillion at the end of 2022, or about 53% of securitized investments. Well, now one can measure the depth of risk of housing collapse for the US. 

Thanks to the accounting rule unless the bank sells the asset there is no loss in the books. But the unrealized losses on banks’ mortgage-backed securities were $368 billion at the end of 2022, according to FDIC data analyzed by the Journal. On the other hand, Banks held $444 billion of commercial mortgage real estate securities at the end of 2022.

Any redemption pressure from the bank end will trigger reverse pressure on these asset classes and papers.

The private equity trigger will massively create a significant vacuum of liquidity in the coming days for the global economy. We might find significant pressure on the PE-backed start-ups and M&A might rise due to a liquidity crunch.  It has been found that PE buys risky assets like real estate and mortgage papers. Private-equity firms have raised record amounts of cash in recent years and announced nearly $730 billion in investments, according to Ernst & Young LLP. Reprising of real estate will lead to massive falls in all corners of the economy. This reprising will hit books which will be another contagion impact.