Commercial real estate challenged, but not distressed: Analyst

Article originally posted on HERE on June 23, 2023

Commercial real estate has faced continued challenges amid the growing trend of hybrid work. Willy Walker, Walker & Dunlop CEO breaks down why are lenders concerned.

Video Transcript

NEWS ANCHOR: Commercial real estate concerns are on the rise with National Office building vacancies climbing to nearly 13% in April as the shift to a hybrid work environment continues to take over. So how can commercial real estate investors position themselves? We’ll dive into that and more. Joining us now, Willie Walker, Walker & Dunlop CEO.

Willie, thanks so much for joining us. First, we’ve seen some of these cracks coming within the commercial real estate space, especially after you saw the issues within the regional banking sector. How would you characterize the state of the commercial real estate market right now?

WILLY WALKER: Challenged. I think challenged is probably the proper way to put it. But I would also say not distressed in the sense that I think to your question about regional banks and bank exposure to commercial real estate. Banks are about 40% of total capital to commercial real estate in the United States. And that’s a total market size of about $4.4 trillion.

And so banks have a lot of exposure. To your question about office, office is a challenged asset class. But I think there’s been a long standing view that all of this, kind of, comes crashing down, and there’s some big cliff that everything’s going to fall off sometime in this near future. And that’s just not the case.

Every property has a distinct maturity on their loan. Each loan has got a distinct leverage level to it. And how banks decide to work on these deals and either refinance them or not refinance them, it will take time to see. And obviously, interest rates have a big impact on that.

NEWS ANCHOR: I mean, you know, each deal is different. But there are some overall overarching themes that are affecting real estate as a whole. And the fact that rates have gone up to the extent that they have certainly has had an effect on the market. You guys do financing of some of these deals. I mean, are you really pulling back on what you’re seeing in terms of activity that you’re willing to do right now?

WILLY WALKER: Yeah, we’ve seen– I mean, lenders are– lenders are concerned right now. They’re concerned about the underlying fundamentals particularly of office. We’re very focused in the multifamily space. We’re the largest lender for Fannie Mae and Freddie Mac on apartment buildings in the country. And multifamily has held up very, very well.

And so if you think about the various asset classes in commercial real estate, industrial has held up the best. And that’s all of the distribution centers that get goods from Amazon to all of our doorsteps. Multifamily is in the second position of holding up quite well. Below that is retail, then hospitality, and then office.

And so as you go into those various asset classes, if you’re lending on them on an industrial property, you’re lending in very similar conditions to how you were lending on them a year ago or two years ago. If you’re lending on an office building, that’s the worst asset class right now. And as a result of it, you’re going to have your cost of capital be much higher. You’re going to have the loan terms be more restrictive. And there are very few lenders that are looking for office financing or office deals right now.

But the real issue there is banks have a lot of exposure to this. And it’s in their best interest to work with the borrowers to try and find a solution. This is very different from 2008, 2009 during the great financial crisis when banks didn’t have the liquidity or the timeline to be able to work with borrowers. They would just have loans default and they would foreclose on them. And they would take over the real estate.

And so I think there has been– there’s a big difference between what happened in the great financial crisis and what is happening today in what you would call the great tightening.

NEWS ANCHOR: OK. And speaking of, kind of, the today framework, let’s talk specifically about office and the troubles there. And I am surprised to see you saying that retail is holding up because I see some different data points talking about– looking at nearly $23 billion of distressed assets tied to retail. I’m going to bookmark that. We’ll come back to that later if we have time. But with office, what do you think is–

WILLY WALKER: Just on that, just real quick.

NEWS ANCHOR: Go ahead.

WILLY WALKER: Just real quick on that because we can deal with it really quickly. If you look at the publicly traded companies, most of the– right now, at a discount to net asset value, the industrial companies are trading close to par. The multifamily publicly traded REITs are trading at about a 10% discount to net asset value.

The retailers are trading at about a 20% discount to NAV. The hospitality is about 30%, and office is about 40%. And that’s just off of the publicly traded comps of what net asset value is now. So that’s just– there is liquidity there. And the only point on retail is what we have seen very much is in-line, well-placed, strip retail has held up very well as consumers continue to spend money. Big box retail has been more challenged.

NEWS ANCHOR: OK, got it. So it’s strip retail holding up. And, OK, you also pointed out that multifamily holding up well. Certainly, seeing the strength there in terms of the numbers. What’s the solution in terms of office? We’ve heard a lot of talk about conversions. Do you– do you see that as a possible solution or what would you say is the solution there?

WILLY WALKER: Conversions will clearly happen. And there are developers who are trying to convert properties. It’s a lot harder to do and a lot more expensive to do than many think. And so there are lots of people in local municipalities across the country saying, let’s just convert all this to residential and we’ll be fine. We need to see people go back to the office. Period.

We need to see people use office infrastructure. And we need to see companies invest in office to make it a place that people want to go to work. Because if not, there’s a big ecosystem around office. It’s not just the fact that the landlord might have a building that doesn’t have tenants in it.

It’s the sandwich shop in the corner. It’s the Walgreens pharmacy down the street. It’s the public transportation that’s making money off someone taking the bus. It’s a taxi cab driver who gets someone to take a taxi into the office, et cetera, et cetera. The parking lot that doesn’t get the parking revenue. All of that’s going to drive down tax revenues to local municipalities.

That’s going to make it so they can invest in police and fire. And that’s going to be a hollowing out of the American city. And so it is up to cities and, quite honestly, all of us to make sure that we don’t lose the urban core that has defined the American experience for so long. And while there are great suburban places here in Denver, Colorado, we are moving our headquarters here in Denver from downtown Denver to a town– to an area called Cherry Creek.

Why? Because Cherry Creek has got restaurants. It’s got a vibrant community around it. It’s an easier commute for most of our employees. Are we leaving Denver? Not at all. Is Cherry Creek three miles from downtown Denver? Yes. It’s very close. But at the same time, that is one more move out of downtown Denver, which really needs to be revitalized.

And I would say that, you know, in Denver, we have a new mayor who’s coming in. Fortunately, the voters of Denver, Colorado voted a mayor who is going to invest in the city and try and get us back on the right track. There are plenty of other cities across the country that have gone in a different tack and are basically saying, we don’t need to attract the investment anymore. We’re OK. And that’s problematic, I think, for the long-term outlook of some of those cities.

NEWS ANCHOR: Yeah. And it’s definitely been very patchy to your point in different cities around the country. We’re going to leave it there for now. We’ll talk to you again soon, Willie Walker, Walker & Dunlop CEO. Thank you.

WILLY WALKER: Thank you.