Will commercial real estate cause bank failures

In March of 2008 Bear Stearns failed and was purchased by JP Morgan Chase for $10 per share. The stock had hit a 52 week high of $133 a share. According to Wilipedia - “By November 2006, the company had total capital of approximately $66.7 billion and total assets of $350.4 billion and according to the April 2005 issue of Institutional Investor magazine, Bear Stearns was the seventh-largest securities firm in terms of total capital.” Among other ventures such as wealth management, capital markets, and equities trading - Bear was in the business of underwriting and issuing mortgage backed securities or MBS. Packaged were a number of risky home loans with their blended interest rates serving as a return for the offerings. When borrowers stopped paying, the securities went bust and the whole house of cards collapsed. What followed six months later was the Great Recession - the largest economic downturn since the Great Depression of the early 1930s. Bear Stearns was the proverbial tip of the iceberg for the titanic sinking of all real estate markets for a good portion of the early 2010s.
 
This March, Silicon Valley Bank failed and was taken over by the Federal Deposit Insurance Corporation. By comparison, SVB is a bank with depositors vs Bear Stearns with brokerage accounts. Depositors place money needed for short term future operations such as payroll, rent, mortgage payments, and salaries. The expectation is the money will be there when needed. If depositors lose faith in their ability to draw down their accounts - a run on deposits occurs. In this case $40 Billion in just over two hours. Unlike the scene in “It’s a wonderful life” where depositors had to line up and wait their turn - a modern run happens across myriad smart phones with the click of a few keys.
 
So, what’s the tie to commercial real estate and how could the collapse of Signature Bank, Silicon Valley Bank, and the sale of Credit Suisse to UBS portend greater peril?
 
Simply. Banks make loans to commercial real estate borrowers. These borrowers run the gambit of those who own and occupy the buildings from which they operate to owners of high rise office buildings loaded with tenants. In the former - a borrower’s ability to make timely payments is conditioned upon the strength of the business and financial wherewithal of the mortgagee. Also, some owner occupied commercial real estate loans are guaranteed by the government through the small business administration. In the continuum of loans - these are relatively safe - which means a bank is not required to add additional dollars to its reserve account for default insurance. But what about the latter example of a high rise office building? Much has been written here about the flux office tenants have experienced with hybrid and virtual workforces. It’s been difficult to predict office occupancy. Versus a single entity - a business occupying a building - you now have multiple tenants - in uncertain times - responsible for paying rent to an owner who’s in turn paying the bank. Should a high rise title holder’s vacancy creep up to levels above 50% - she must resort to extreme measures to rent the vacant space. Such things as free rent, beneficial occupancy, tenant improvements, broker fee bonuses, and moving allowances are employed to attract paying customers. ALL of these things cost money. I recently experienced these items totaling 45% of the consideration of the lease! But the problem is compounded if the physical plant of the structure is aging and needs capital improvements such as a new roof, elevators, lobby improvements or collaborative outdoor space. Once again - very expensive. Now a catch 22 exists. Declining occupancy - high tenant acquisition costs - further vacancy - lack of dollars to renovate an aging structure - solution? Give the building back to the bank. Now a fire sale takes place to find a buyer of a distressed asset for which the lender must boost its reserve accounts.
 
This over simplified example shows how commercial real estate could in fact cause additional banks to fail. 
 
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.