So today we're going to talk about a real estate crash that nobody's watching.
So there's a lot going on in this first slide.
So obviously, some of you may know that that's Chairman
Powell, the head and chairman of the Fed.
What the Fed's done in their last PAN meetings is raise interest rates.
When I look at real estate, I look at the whole picture.
So as you can see here on the left side of the slide, you've got your single
family on the right side of the slide, you've got your commercial.
But you what you need to understand is that they operate very, very differently.
So on the left side of the slide, on the residential market, of course,
you have very different kind of behavior as a result of interest rate increases.
On the right side, you'll see the commercial side, which represents
office, retail, industrial mall, self-storage, all kinds of other things.
And even those loans oftentimes are recourse, are non-recourse.
In other words, they're not like residential.
However, the thing in the middle, that's the bank.
The bank connects at all.
So things that may not be going on in the residential
market might be going on in the commercial market.
And this video is going to talk about
why you need to pay attention to the entire real estate market
and not just the niche that you're handling today.
So what we're experiencing right now is a debt crisis.
We had a debt crisis in 2008.
It was about residential.
Now we have a debt crisis in 2023
and 24, which is, of course in commercial, very different.
But it's still a debt crisis
and the banks are square in the middle, as you guys have seen already.
We've had multiple banks go down completely out of business,
which we're going to talk about in a minute.
But the bigger issue, of course, is
that many of these banks have 3% loans.
When today the savings rate is 4%.
Doesn't take a mathematician to understand
that when you have 3% coming in and you're paying out for
because deposits are a liability, it's a negative issue for the bank.
As you guys know,
I love Buckminster four and I love to talk about precession and lag.
So a great illustration
is when you drop a pebble in the pond and it has ripple effects.
And the pebble in the pond, of course, are the ten interest rate increases
from the Fed, affecting everybody very differently.
So in February of 2022, some of you know that inflation
was almost 8% or a 7.9%.
The federal funds rate was zero and the average sales price of a home
during this period of time was 514,000, as you can see.
So after ten rate increases, what's changed?
Well, inflation has only come down to 5%.
And mind you, the Fed actually has a target of 2%.
So we've been able to reduce inflation,
which is good from 8% to 5% with ten increases.
But what's interesting, the cost of a single family home is about the same.
That has raised rates ten times and the federal funds rate is over 5% now,
of course, affecting the entire real estate market.
But the single family market actually has not moved that much.
It certainly has. Is specific areas.
Some areas are higher, some areas are lower.
But if you look at the average sales price, it hasn't moved that much.
What has changed a lot
is that the interest rates over here made the homes affordable
and the interest rates over here make them very expensive.
So what exactly has happened during that 12 to 14 month period?
That's what I call lag.
So an interest rate increase affects many people immediately,
like obviously credit cards or somebody who's buying something today.
But for many of us, it shows up over time and that's what we call a lag.
So rising interest rates had an immediate impact
on residential, but has a lagging impact on commercial.
That's why you need to look at these markets very differently.
So with residential banks, look at credit scores, with commercial, they look at net
operating income or no, I which we talk a lot about on this channel.
What's happened with and why is that the know why has gone down largely
and the cost of debt has gone
up which has driven
the value of commercial real estate down significantly,
which we're going to talk about in a second.
So what happens after ten increases?
Auto sales are down real estate sales are down 20%, inventory is creeping
up, but prices for residential haven't really adjusted that much.
But commercial real estate values have significantly adjusted.
Anywhere from 10 to 40%, in my estimation.
So real estate values are down largely, primarily in the commercial markets.
Savings rates are up, but everyone's afraid of the banks.
So this is what I call a fork in the road.
So as you can see, to the left is residential.
To the right is commercial.
So right now, facing the commercial market, we got $4.5
trillion in debt maturing that you need to be concerned about.
On the same token, prices haven't adjusted that much.
However, there are certain markets that are getting clobbered
and other markets that are rising like crazy.
But the rising rates are keeping people in place
because they have trapped equity and it doesn't make any sense for them
to leave their current home and buy another one, because to do
that would increase their mortgage and their monthly payments significantly.
So they're staying put.
So inventory is not growing that much, but days on the market is growing a lot.
One of the main things we're going to talk about in this video
is that $1.4 trillion of commercial debt
is going to mature by the end of 2024.
And that's not very long, folks.
That's only a year and a half away.
Let's first take a look at 2008 and how a comparison 2023
or most of you know, I went through the 2008 crisis.
So these numbers are very, very interesting.
As you can see, the black line are the cap rates
and the dotted line is the ten year U.S.
Treasury.
These are very big markers for the real estate industry.
The green represents the spread, which is just the difference between the two.
So the 2007 2008 crisis had mostly to do
with people actually buying homes that couldn't afford it.
They were packaged up, sold off the Wall Street, and everybody bought them.
And then when they actually had to pay, they cut it
and then the entire market collapsed.
2728 was a residential real estate crash.
2023 24 is going to be a commercial real estate crash.
Now let's take a look at the ten year Treasury as you guys can see, about 2008.
It started to go down to zero.
During this time, it was basically free money.
This is actually what created the asset bubble that we are in today.
Then, of course, we had the pandemic and all these other factors that contributed
and the disruption that we're starting to see, the starting to show up
as far as inflation and inventory and valuations that are going down.
So the rates went down, creating the bubble
and now the rates are going up, the flattening, the bubble.
It's that simple.
One thing pay attention here is that people's dynamics change as well.
So as you start to look at office buildings, you start to recognize that
work from home and vacancies are starting to creep up and expenses are also rising.
So utilities are up, property taxes are up, insurance is up.
All those kinds of things that affect a landlord are also up.
While that may not matter to you, you need to understand
when occupancy is going down and incomes going down
and expenses are going up and the cost of debt is also going up.
That creates a recipe for disaster.
And that's a prediction I'm making because commercial real estate is in big,
big trouble.
We're going to go into each category in a minute.
This is a very interesting slide, which was done by Moody's
that I thought was very, very good that I want you to take a look at.
There's a lot here, so I'm going to explain it to you.
For those of you
who have been following the other videos, do you understand what A.I. is?
And that's the most important piece to look at here.
So you can see they started with a $10 million A.I.
and a 5% capitalization rate.
What's important for you to understand is it capitalization rates
have actually gone up, as have the federal funds rate and interest rates.
So now let's take a look at three scenarios.
You've got green, yellow, red, obviously like a stoplight.
So green means 20% growth.
As you can see.
Yellow means no red growth
and red means 20% red growth.
You got to start somewhere.
So that's what they've used for this chart.
And I think it's very compelling.
I can already tell you that red growth is declining in many
areas and across many asset classes right now, specifically
in retail and office and in some cases even multifamily.
So every market is going to be a little bit different.
But I think this is a good reflection
of the different scenarios that could happen in the next 18 months.
Now, let's first
just take a look at the yellow category, which is exactly where we are,
because there's certainly no rent growth happening at the moment with the higher
interest rates and the higher capitalization rates.
Moody's is already saying that we're at least a 15% decline.
And if we have negative rent growth, which is actually happening,
we could be up to 40%, as you can see from the narrative here.
Moody's is saying that there could be up to a 40% correction
in the value of the real estate.
What that means is when those assets loans mature.
In other words, when they're up and they're due, the bank is now
going to value the property and they're going to size the loan
on today's value as opposed to what what was worth in the yellow scenario.
You can see it's a $28 million cash infusion.
And in the red category, it's a $75 million cash infusion.
And I can assure you what that means
is that every investor that represents the equity or the LPs,
that money is got on both the yellow and the red.
And now, of course, the banks concern, because
now you're getting into the actual loan balance.
So the landlords in most cases are not going to fund
28 million to 75 million to keep one deal.
They're going to let it go back to the bank
because most of these assets have non-recourse debt.
In other words, there's not personal guarantees against them.
And so they're going
to let the banks handle these and they're going to take these back.
This is what I'm concerned about, because this scenario exists across
multiple asset classes as we're going to go to in a minute.
So right here is the outstanding 4.5 trillion in U.S.
debt backed by income producing multifamily and commercial assets.
As we go around the clock here, you can see that
the top 25 banks actually only hold about 12%.
The regional banks there are a little bit more in trouble.
I believe you got your agency, which is Freddie and Fannie,
your life insurance companies, your commercial mortgage backed
securities, your collateralized debt obligations, your CDOs.
And then, of course, others.
And this is something that you should pay attention to,
because as these loans default, they're going to affect
all of these institutions very differently.
So now let's get a little more focus for the next 18 months,
1.4 trillion loan maturities as a percentage of assets by lender.
And here you can really see that we've got some exposures
in the banking system right there under the depositories,
the CMBS, and a little bit out of the credit companies in the warehouses.
If you take the 1.387 trillion that's represented here
and apply the Moody's 15%, you have $208 billion of loans at risk.
If you use the 40%, it jumps, of course, over to 500 billion.
So now let's get a little bit more detailed.
Of course, this is just through 2024.
You got multifamily office, industrial retail, hotel, health care and other
IT totals over there in the far right category, over $700 billion.
So the assets to watch are certainly going to be the hotels sector
and the office sector because they're the ones suffering from the highest vacancy.
Multifamily, of course, is still going to be an issue on anyone
that has that maturing in the next 18 months
because for sure, their values are definitely less
than what they purchased them for just two years ago.
So all these debt defaults are going to make their way
through the banking system, the same bank that makes loans on the residential side.
So this slide represents
the total direct commercial real estate exposure by asset class.
And this is, of course, what we're starting to see today.
The reason I wanted to talk about this chart is because the regional community
and small banks have significant exposure in the commercial real estate market.
As you can see, 16, 24 and 18%, which represents, of course, thousands of banks.
This is a tsunami that is coming that has not yet been experienced.
And what you've been watching so far has been the banks exposures
as a result of the higher bond costs and people wanting their money
and then having to sell those bonds in order to get your money out of the bank.
That's what's mostly creating a lot of these bank failures so far.
This is just the tip of the iceberg.
What's important to understand is
when the landlords are starting to take a look at their individual assets
as their loan starts to mature, they're going to have to make a decision.
And that decision is, do I keep a 50% vacant or say
a 25% vacant property paying the cash and actually keep the asset?
Or do I let this go back to the bank?
So what's going to happen is many banks are going to take back these assets
that are not going to be worth the loan at all.
In fact, many are going to be a massive liability
to the bank because of 50% vacant building.
We're already starting to see
sell in areas like Seattle, San Francisco, Chicago, New York, etc..
Many of these assets are trading for 25, 30% of what they were just two years ago.
So the bank shouldn't be holding on to assets that nobody's going to want.
For example, a big 50, 60, 70 storey office building.
Nobody's going to want to buy it at 50% occupancy, especially,
especially now we're in a work from home environment
and those companies are actually requiring less and less office space.
And don't forget that rents are also declining
and expenses are also going up.
So these assets are going to be toxic.
They're going to be on the bank's books for quite some time
until they get priced accordingly and the market corrects.
So the question is what will actually happen to the banks
when they get these assets back?
So this is what's similar in 2008,
because it did happen in residential and of course in many multifamily properties.
What happens is the bank actually has to write down this asset
and that further wipes out their equity even more.
So this graphic, as
are seven ways of a financial crisis, or I'm calling a debt crisis,
as you can see in 2007, 2008, all seven of these things happen.
I was in the middle of this
and they all progressed at different paces,
but they all progressed and they all happen.
2023 we've had four of the seven already happened
and those four are as follows.
More financial institutions are looking weak.
The economic or asset price growth has definitely slowed down.
People are definitely running from weak financial institutions.
As you're starting to see capital move
into other type of stronger places.
And of course, banks are lending less and people are spending less.
Well, we still have yet to see is a significant economic slowdown,
asset prices declining further, which I just predicted.
And of course, financial institutions are loading assets into a fire
sale is exactly what I bought in 2009, 2010 and 2011.
They were toxic assets owned by the bank.
So of course I don't want all doom and gloom.
So I gave you a list of things that I'm doing personally.
So the very first thing is you need to take a look at your asset exposure
like the banks.
If you don't understand what that means, you need to dig in further to
you need to take a look at your asset allocation.
If it's having commercial real estate, for example,
like the allocations I show up for the banks,
you might want to take a look at that and make some adjustments for these defaults.
Three Sell off all marginal assets, so anything that's negative
or no cash flow course, we don't know where interest rates are headed.
Certainly they're going to be flat
for a period of time before they ever get adjusted downward.
And when they do get adjusted down or that just going to create more inflation,
which of course the Fed is still fighting for.
You haven't heard me talk about this enough because your debt,
because it'll hedge the upside if interest rates continue to go up
and you'll always have the opportunity to refinance on the downside.
I've build your cash reserve. Cash is king.
My partner, Ross and I have actually done some cash in refinances
where we fixed our debt and require a cash infusion
to hedge that number, which was just buy with us.
And we were able to do it because we had adequate cash reserves.
You expect more stimulus money and money debasement.
We saw this in 2008 as the government stepped in
or the Fed to actually backstop some of these banks
that could potentially be in trouble as a result of the defaulting loan.
Seven Please use inflation
as your 2023 to 24 strategy,
because if you do that, you'll definitely be on the other side of this.
What that means is if you have a two and a half or 3% loan today that is considered
an asset, you're beating inflation as a result of holding on to that asset.
Do not sell that property because that low interest rate loan is an asset today.
Eight Expect loan defaults due to the commercial real estate exposure.
Nine Expect bank instability and failures.
You're going to see this.
What's interesting is that in 2008, in 2009,
no one lost their deposits in any of the banks.
Some of the bigger banks just gobble up the smaller banks.
So there were hundreds of banks and failed.
Believe it or not, after 2008, all the way up to 2015,
the big banks just gobbled up the small banks
and the depositors were saved during that period of time.
These next three saw the problem stay macro and of course, be patient,
and I think at least 1 to 2 years to let this play out.
So we'll solve the problem
means the banks kind of have a problem with these toxic assets.
Be careful that you're not catching a falling knife
as they continue to decline in value.
But you can still solve a bank's problem
by acquiring the assets on their books because banks are not supposed to.
All real estate.
You are to stay macro,
stop watching the news and try to figure all this out.
Just understand that the tsunami is coming
and it will be fixed somehow, one way or another.
It'll either be fixed with money or we'll start to see big devaluations in banks.
As banks start to take on this toxic debt.
And lastly, just be patient.
Don't just expect that these things take time.
And at the end of all of this, there's going to be massive,
massive opportunity. And that's exactly
when you should be diving in and solving some of these problems.