So today, real estate owners all over the world are trying to figure
out, is the juice worth the squeeze?
So what does that mean exactly?
What it means is, is the end result.
Worth the process to achieve it?
In other words,
do we work out these buildings with all the issues,
with interest rates, with vacancy, with the lenders,
with all of the things that are going on right now with real estate?
Is the juice worth the squeeze?
the juice could be considered a derivative.
So let's say that when I squeeze this orange like this right now,
this derivative should be cash flow,
value time, or even your ego.
But it's a derivative.
For example, if you own a gold coin, then you have gold.
But if you own the ETF of gold, that's actually a derivative of gold.
So cash flow is a derivative of real estate.
When it comes to real estate, We all know that it comes in all forms.
Commercial, single family office, retail,
multifamily, industrial mall, all of that.
It's all one big category of real estate.
So I did a video called The First Domino to Fall,
which is specifically about commercial office buildings,
which, as you know, has changed a lot due to work from home
and is suffering from high vacancies and high expenses,
and many of which are not worth the value of what they were just a year or two ago.
So I found this article, which is owners are walking away from downtown
San Francisco buildings, there were 30 of these buildings
that they mapped that are in serious financial crisis.
And of course, the city is concerned because it's potentially
an annual tax loss that could reach nearly $200 million.
what that means is that these cities are not going to have these tax revenues
to pay for all the services that they need to maintain those cities,
including fire and police and those kinds of things.
so let's take a look at a typical capital structure
of any piece of real estate anywhere in the world.
So as you could see at the top represents your equity.
And at the bottom represents your debt.
So whatever you're buying a building
like this, for example, let's say this building's $100 million,
the debt might be 75 million and the equity might be 25 million.
and that equity can come from anywhere, mostly high
net worth investors or pensions or life companies or whatever.
And the debt, of course, can also come from anywhere,
which primarily in this case seems to be small and regional banks.
This is a typical scenario for any real estate purchase anywhere in the world.
So office buildings right now have the most pressure of any asset class
in their real estate category.
So now let's take a look at this exact property.
So do not work from home. There's much higher vacancy.
In some cases over 50% in many of these downtown office towers.
And this is happening across the United States right now.
So when the income is down due to vacancy and expenses are also up,
let's not forget about those in the form of property taxes,
utilities, insurance, etc..
when income is down,
that means that there's not enough money to pay for both the expenses and the debt.
So in this particular case, a high vacancy creates financial stress
for many owners of those buildings, which of course means
that they're in high risk of loan defaults,
which are then going to make it into the small and regional banks.
now let's take a look at how this plays out.
You have your debt and your expenses, and typically you have cash flow after that.
But in this case, you have high vacancy, which now
means that you're not able to pay for all your expenses.
And of course, now even potentially the debt
So when income's down due to vacancy, most landlords
are not going to be able to pay for both their expenses and their debt.
So in this scenario, we're going to call this the Triple Crown.
So what we have going on here is we have income is down
due to work from home and of course, higher vacancy means
less income to pay for both debt and expenses.
Number two, expenses are up in the form of higher property taxes, higher
insurance, higher utilities, higher labor, higher costs.
All those kinds of things are also driving up the expenses.
And three, the cost of debt is also going up
because rates have gone from 3% to now over six.
So if you're an owner of this office
building and you have high vacancy high expenses and high that you're
now faced with, the choice is the juice worth the squeeze?
Do I keep this building or do I turn it back over to the bank?
so what's going to happen
at this point is the landlord and the partnership and the lender
They're going to look at this Triple Crown scenario and say this asset is now
not even worth the actual debt that was originally loaned upon it.
So what happens when the asset is actually worth less than the debt?
Well, the first thing that gets wiped out is, of course, the equity.
and then, of course, you got to decide
how much is the asset worth as compared to the original debt.
In many cases, it could be 40, $0.50 on the dollar.
there's two scenarios that I want you to focus on in the next 18 to 24 months.
The first one is how much of this toxic debt
is going to spill over into the small and regional banks.
There's been reports that as much as 70% of
the commercial paper is held in those areas.
this, of course, could produce more banking problems down the road.
The second scenario, which will take longer to play out.
Is going to be who's going to pay the property taxes
on some of these big failed assets?
And what's that going to do to the downtown city?
Core?
What's that going to do to their budgets?
And how are they going to maintain
these same cities when those property tax payments might go away?
many of these properties are selling right now.
You can Google these and see that they're trading for 20, 30, $0.40 on the dollar.
this potentially could happen in many asset classes of real estate
because of these rising interest rates and the way people are now
starting to work from home. what you need
decide is, are these properties or anything that you're looking at?
Is the juice worth the squeeze?