Interest rates are up, real estate valuations are down, and inflation is cooling. The latest CPI numbers are out, and inflation is at a 5% annual rate as of March 2023, still well above the Fed’s 2% target rate. The banking system is being stressed to levels that are making the Federal Reserve consider a pause in their rate hikes. As a real estate investor, this can be particularly good news. Here are exactly what the opportunity indicators are showing:
Commercial Loan Maturities
A leading indicator of broader distress finally playing out in the marketplace is in maturing commercial loans that were underwritten at a certain debt service coverage ratio and at much lower interest rates. Now that these loans are expiring and returning to the market at much higher interest rates, there is a wave of defaults expected to hit the broader markets.
According to Trepp, there is $52 billion worth of loans comprised of just over 3,000 properties contained in the Trepp database maturing over the next 24 months where the current debt service coverage ratio (DSCR) at the property level is 1.25x or less. Almost half of the properties are multifamily with roughly 1,450 properties meeting the above criteria. Additionally, $17 billion of the $52 billion has occupancy below 80%.
Personal Bankruptcy on the Rise
Families have increased non-housing debt by 75% over the last 10 years, and are now cutting back on expenses, vacations, house upgrades, and more to help offset the costs of a more expensive inflationary world. Unfortunately, the projection for personal bankruptcies is trending higher, which will lead to defaults not only on residential properties but also on commercial properties which are personally guaranteed by individuals.
Fallout From the Banking Sector Stresses
Recently, the US central bank economists have predicted a US recession will begin later in 2023, citing fallout from the recent bank failures of Silicon Valley Bank and Signature Bank. This will cause the unemployment rate to rise through early 2024. Additionally, many officials have indicated “there would be some tightening of credit conditions.”
This in turn will make it harder for commercial loans to refinance, especially if they are underperforming.
The Federal Reserve is playing chicken with the economy and a freight train called inflation. Yes, the freight train may be slowing, but it is still going too fast for the likes of your average household in the United States. All these signs point to a slower economy and even signs of distress.
It is during distress that the best opportunities present themselves, and the Recentric team is actively seeking out opportunities in this dynamic market. In the words of the great Warren Buffet, “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”