The Monday Morning Quarterback
A quick analysis of important economic data released over the last week
By Elliot D. Pollack & Co | Rose Law Group Reporter
The recent demise of Silicon Valley Bank and other regional banking institutions has started to ripple through other parts of the economy, particularly the commercial real estate industry. Regional banks provide a majority of commercial real estate loans in the country, and they are now exposed to declining property values as the office market attempts to rebound from the pandemic. The collapse of SVB and others has led depositors to move their money from smaller to larger banks, draining the regional banks’ balance sheets and putting them in untenable situations in dealing with maturing loans. The most critical issue facing the banks is the falling value of office buildings. Shrinking tenant demand, high vacancy rates, high levels of sub-lease space due to the pandemic, and the flight of tenants to high quality buildings all are compounding the issues facing both banks and landlords.
Although the future of office occupancy is still fully unknown, there is concern among landlords that in-person work will never return to pre-pandemic levels. Some companies are mandating at least three to four days of in-office work while others are allowing more flexibility. This means companies can reduce their occupancies by reducing conventional workstation space and moving to shared desks. As of January this year, office occupancy exceeded 50% of pre-pandemic levels for the first time in the ten biggest cities according to Kastle Systems. We know that the fundamentals of office leasing have changed, but what the future holds is still uncertain.
The impact on the regional banks could be significant. Some sources indicate office values have declined by 25% over the past year, meaning that some office buildings are worth less than their mortgages. On top of that, about $80 billion in office building debt is scheduled to mature in 2023. During the pandemic, lenders and borrowers worked to reach agreement on loan extensions and other short-term measures. That option has now passed. Refinancing of loans will be more difficult as underwriting becomes more restrictive for the office market. Fed Chairman Powell has indicated that the difficulties in the office market won’t prevent the Fed from further interest rate hikes – although the last increase was only 0.25%.
In order to reduce the number of foreclosures of office properties, it is likely going to require intervention by federal and industry leaders which buys the office industry and the regional banks some time. The only good news is that this is not a repeat of 2008 and 2009 when the whole real estate industry was at risk. This time it is commercial real estate, particularly the office sector, rather than sub-prime and collateralized residential mortgages.
- The U.S. economy continued adding jobs last month, with the unemployment rate dropping to 3.5%, near all-time lows. There were 236,000 jobs added in March, bringing the total for the year to 1,034,000 or a 345,000 average. The average monthly employment gains in 2022 were 399,000 jobs. Both 2023 and 2022 remained above the 2010-2019 monthly average gains of 183,000.
- The primary gains were in Leisure & Hospitality (72,000), Private Education & Health Services (65,000), and Government (47,000). Only Construction and Manufacturing sectors lost jobs in March.
- Jobs openings fell below 10 million for the first time since May 2021. February’s job openings were 9.9 million, down from 10.8 million in January. The number of hires outpaced the number of separations, 6.2 to 5.8 million. The number of quits rose by 4.0 million, while the number of layoffs was 1.5 million.
- ISM’s manufacturing and services PMI both declined in March. The services PMI (the economy’s largest sector) dropped to 51.2, the lowest reading in nearly three years. While the service index remained above 50 (any number above 50 signals growth), the manufacturing PMI fell to 46.3 and was below 50 for the fifth month in a row.
- According to the Information Market, March data showed both new home sales and resales improving from February. New home sales were up nearly 41% for the month and 9.1% from a year ago. Resales were up 31.5% for the month but remained 37.1% below last year’s volume. The median sales price rose 2.1% for the month but was down 7.7% from a year ago.