Is the Commercial Real Estate Market Going to Lead Us Into Recession?

Although I've experienced significant adversity, I also feel very blessed.

I was blessed to have a hardworking and resilient mother who got us through my difficult childhood and set me up for the future. 

I was blessed to get into the top business school in the world – the Wharton School at the University of Pennsylvania. This is where both Warren Buffett and Elon Musk went! So did Donald Trump…

Lastly, I am blessed to be able to tap into the network of my friends from university when looking at different aspects of the economic environment. Many of them have gone on to do great things and have tremendous insight.

One of my oldest and best friends focused on commercial real estate. He began his career at one of the most famous real estate firms out there, spent a few years at one of the biggest investment banks building their real estate business, founded the real estate division at one of the most significant hedge funds, and then – for the last 20 years – has managed his fund.

In addition to having access to billions (trillions?) of deal flow and having done over $100 billion of deals himself, he is also a stone-cold money-maker!

Recently, I had the opportunity to connect with him and talk about the commercial real estate market.

In particular, the perception is that commercial real estate has a huge problem. With interest rates having gone higher, large refinancings looming, and the decline in office occupancy – the popular view is that we have a significant credit event waiting to happen.

What does HE think?

His first point is that almost nothing at all is happening in the market. In his words, it is "stuck."

Both borrowers and lenders understand there are potential problems. A very healthy amount of money is also ready to buy up distressed assets.

With the recent perception, however, that rate cuts were looming – none of the borrowers were willing to sell.

Why sell now when there may be a half-dozen rate cuts in 2024?

At least, this was the perception…

We asked him whether these borrowers thought these rate cuts were realistic scenarios. He said they will believe what they want to believe.

Does this change now that the new perception is for far fewer rate cuts in 2024?

Somewhat, but there is still little motivation to get deals moving in the commercial real estate market.

One of the big misunderstandings about the real estate market and the status of these "bad" loans amongst non-real estate people is that these loans HAVE to come due.

This doesn’t take into consideration the owner of the loans.

None of these loan owners want to own the real estate, especially in this market.

They would much rather roll over the loan at a slightly higher interest rate and let the borrower try to figure it out, especially with interest rate cuts on the horizon.

Sure, there will be some loans so far gone that they will have to deal with them, but this is only a tiny percentage.

Remember that the lender will do everything possible to AVOID taking over and dealing with the property themselves.

We discussed this a couple of weeks ago in our note (link it): "The System is Rigged."

Unsophisticated market observers don't understand that it is in the best interest of everyone NOT to have banks and real estate developers go under.

There are real problems out there, but the magnitude of these problems is manageable for the system for now and, in his opinion, for the foreseeable future.

Do you think commercial real estate will push the economy into recession? Let us know in the comment section below.

One last interesting insight was his surprise at how little impact that lack of real estate development has had on the overall economy.

While new housing is growing to deal with the lack of existing housing sales, most other areas of real estate have crawled to a halt—especially areas like office and multi-family.

Historically, this has had a decent impact on construction employment and the economy.

Instead, construction employment is booming. What is going on?

The answer is infrastructure.

Whatever you think of the poorly named Inflation Reduction Act of 2022, there were A LOT of financial benefits to drive development.

We are seeing a boom in industrial and manufacturing construction that is more than offsetting the weakness elsewhere.

My friend is not a Pollyanna. He is one of the most hardworking business people I know, and he can make just as much money off of failure in the economy as success.

As a result, his relative constructiveness leads me to believe that – while we may end up with some severe financial crisis in the future – it is unlikely to come from commercial real estate in the near term.

Check out Enrique Abeyta’s conversation with Carol Roth on the HX Podcast.