Distress in Commercial Real Estate Bonds Hits All-Time High

Commercial real estate continues to suffer despite the Federal Reserve’s attempt at ameliorating the capital markets with a 50-basis point rate cut in September.

The pain is especially apparent in the so-called “CRE-CLO” bond market. CRE-CLO bonds are packaged commercial real estate mortgages comprising short-term floating rate loans. These bridge loans were recently, and most notably, used to facilitate the biggest apartment investment bubble in history, but were also used in financing other commercial real estate sectors including office, retail, hotel, industrial, and self-storage.

Most of the current batch of bridge loans originated in the 2020-2022 period—when benchmark rates were near zero and commercial real estate prices were peaking—and carried maturities of three to five years. Benchmark rates are now much higher, prices much lower, and property performance far worse than anticipated. Thus, a wall of maturities is staring borrowers, lenders, and bondholders in the face, all while underlying property performance disappoints.

Despite attempts by lenders to extend and pretend—kicking the can down the road in the short term to avoid defaults until the Federal Reserve lowers rates enough to bail them out—their delusions of reprieve may be fading fast.

Apartment Investors Play Checkers Instead of Chess

At the end of Q3, the distress rate for CRE-CLO loans across all commercial real estate sectors reached 13.1 percent, an all-time high. Distress in this instance is defined as any loan reported 30 days or more delinquent, past the maturity date, in special servicing (typically due to a drop in occupancy or a failure to meet certain performance criteria), or any combination thereof.

Figure 1

While roughly one in seven loans meets these criteria, the weakness is concentrated in two or three sectors.

Unsurprisingly, office properties have the highest rate of distress, with nearly one in five CRE-CLO office loans experiencing current distress. This is to be expected after the covid panic of 2020, subsequent to which various “work-from-home” directives essentially made the office market obsolete.

For similar reasons, distress is also high in the retail segment, as all but the most well-heeled retailers were forced under by the maniacal and criminal government edicts of the time.

However, the real story here is in the apartment, or multifamily, sector. Seen in Figure 1, the distress rate for apartments touched 16.4 percent in August. An astonishing number, indicating that one in six apartment bridge loans were distressed. The improvement to 13.7 percent shown for September is seasonal, as renters settle in at the start of the school year.

While this picture is bad enough, the reality under the surface is far worse. As reported by the Wall Street Journal, using Q2 data from MSCI, the batch of currently distressed apartment bridge loans comprise roughly $14 billion in total loans, but there exists an additional $81 billion in potentially distressed loans. MSCI categorizes loans as “potentially distressed” if they have seen delinquent payments, forbearance (when the lender lets interest payments accrue rather than taking a default action), or where key performance metrics like occupancy and net operating income are dangerously low.

Figure 2

The arithmetically-aware will note that if the $14 billion of currently distressed apartment bridge loans comprise a roughly 14 percent distress rate at the end of Q2 (as shown in Figure 1) and there are an additional $81 billion in potentially distressed loans not yet categorized as “currently distressed” (as shown in Figure 2), then MSCI data implies that 95 percent of all apartment bridge loans are either currently distressed or in imminent danger of distress.

While astounding, this level of distress will come as no surprise to veterans of the apartment market. In the 2020-22 period, bridge loans of this variety were ubiquitous above a certain minimum loan size. And, because of the extreme and reckless nature of money printing undertaken by the Federal Reserve during this time—when interest rates were effectively zero—lenders underwrote property acquisitions with a 1.0x debt service coverage ratio (“DSCR”), meaning the initial net operating income of the property was projected to just cover interest payments, with nothing left over.

Bridge loan interest rates floated at a spread (typically around 350 basis points, or 3.5 percent) to the Secured Overnight Financing Rate (“SOFR”), which was essentially 0 percent until mid-2022. Because of the 1.0x DSCR standard, a property acquired during this period that had net operating income of $1 million would have also had interest payments of $1 million at the then-prevailing interest rate of 3.5 percent.

SOFR is now 4.9 percent, indicating a total interest rate of 8.4 percent (SOFR + 3.5 percent spread). This same property now has interest payments of $2.4 million while net operating income is unlikely to have increased to any significant extent, if at all. Insurance and property tax increases in particular have damaged apartment profitability while rent increases have been difficult to execute in the face of stagnating real wages. By the same token, absurdly optimistic renovation plans have been impossible in the face of cash flows increasingly shunted towards paying interest.

The Amazing Disappearing Rate Cut

The high amount of potential distress in CRE-CLO bonds, and the loans that underlie them, indicate an expectation on the part of lenders that help is coming in the form of lower interest rates. After all, capital markets have become used to being bailed out by the Federal Reserve, all but demanding that the taxpayer—not they—be held responsible for their poor decisions. Nevertheless, the Fed’s recent rate cut is proving not to be the magic bullet on which lenders relied.

By August of this year, futures markets had fully priced in a 25-50 basis point Fed rate cut in September, and were expecting additional 25 basis point cuts in November and December. This expectation for the Fed Funds Rate carried over into Treasury yields, a key benchmark for the commercial real estate industry. Particularly important in the case of distressed bridge loans since any hopes of refinancing are placed not on more bridge loans—which are now much less pervasive—but on the fixed-rate agency market comprising Fannie- and Freddie-backed apartment loans, which prices loans off a spread to treasuries.

At the beginning of August, as markets priced in 75-100 bps of Fed rate cuts by year-end, 10-year Treasury yields reacted accordingly, dropping from 4.30 percent in late July (they had been 4.70 percent in April) to 3.65 percent in the middle of September. As of early November, most of that move had been erased—with yields back near 4.30 percent—roughly where they were prior to market pricing in this year’s Fed rate cuts.

Fear and Trembling

Undeniably, participants in the commercial real estate market—apartment bridge lenders in particular—are relying on loose monetary policy for their immediate salvation. They may get their wish. While Treasury rates have moved stubbornly higher, market forces only mean so much if the Fed decides to supplement rate cuts with purchases of treasuries, driving yields lower—another round of quantitative easing.

Nevertheless, to the extent they’re allowed to be heard, market signals are unmistakable. A regime that can’t stop spending and continues to appropriate the property of its citizens through inflation will provide upward pressure on Treasury yields, all else equal. In a free market context, the rent-seekers that comprise the commercial real estate market will have to work out their own salvation.

Originally Posted at https://mises.org/

zerohedge
Economics , News , Politics , Science
December 7, 2024
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The Miserable Cost Of An Open Border

Authored by Seth Barron via RealClearPolitics,

The Biden-Harris experiment in dissolving the U.S. border has wrought massive changes to American society, most of which will not be understood for years, if not decades. Since 2021, U.S. border officials have had at least 10 million “encounters” with migrants, many of whom were allowed to enter the country. There is no telling how many more aliens entered the country without encountering enforcement agents. The population of the United States may have increased by as much as 15 million people in just a few years.

This massive flow of humanity crosses multiple national borders, involves every mode of transportation, accounts for billions of dollars paid in fees to smugglers, and describes a fantastically complex economy of suffering and hope. In an effort to get a handle on this human tide, noted muckraker James O’Keefe – known for his hidden camera “gotcha” interviews with abortionists, media executives, progressive nonprofit executives, and other degenerate types – traces the migrant onrush from its source, and seeks to trace the machinery of profit and influence that is conducting it from great removes.

“Line In The Sand,” the resulting documentary, is a remarkable and humane exposition, revealing perspectives and images American audiences have mostly been prevented from seeing. O’Keefe and his intrepid team begin on the U.S. side of the Mexican border, where we witness migrants crossing the border through holes that their guides have cut in a fence that serves as a target as much as a barrier. Infrared cameras show dozens of illegal aliens streaming toward “pick-up” vehicles on the U.S. side while smugglers – presumably cartel members – a few feet away taunt O’Keefe and his group. “What if I were to run up to them right now, what would happen?” O’Keefe asks his guide. “I would highly advise you against that,” he is told, in a classic understatement.

The fact that coyotes and other human traffickers are paid to assist northbound migrants with their passage is no scandal; we all know what their motivations are and why they are doing what they do. But O’Keefe documents multiple examples of U.S. Border Patrol agents standing idly by while illegal aliens cross, virtually under their noses. “Why aren’t you doing anything?” he asks. “Have a good day, guys,” a border agent desultorily responds before driving off in the general direction of the episode. Later, a migrant stands in front of a Border Patrol truck, clearly trying to alert the agents of his intention to surrender, but is studiously ignored until O’Keefe and his team call their attention to him.

There is a kind of sad comedy in the operations of U.S. border security, and O’Keefe is not unsympathetic to the absurd position that border agents have been put in. Trained to defend the national border and to serve as the first line of defense of American soil, these agents have been recommissioned as a perverse Welcome Wagon for illegal aliens, charged with making their undocumented and uninvited entrance to the United States as commodious as possible.

Looking to get deeper into the heart of this migratory avalanche, O’Keefe went deep into Mexico, to the city of Irapuato, about 150 miles northwest of Mexico City. Irapuato is a popular railway junction where thousands of migrants climb aboard “La Bestia,” or “The Beast,” a cargo train that chugs northward toward the United States. In the film’s most remarkable footage, O’Keefe and his team join with migrants, mostly from South and Central America, to ride The Beast, also known as “el Tren del Muerto,” or the Train of Death. O’Keefe talks to the migrants without condescension, asking them their destinations and what they plan to do when they get there, and their concerns about the perilous nature of the journey. We see the film crew race to jump on a moving train and clamber on top to sit in a pile of coal; O’Keefe is shocked at how truly dangerous this small element of the trip is and sympathizes with the migrants’ difficult choices. These scenes are among the film’s most affecting, along with the crew’s random encounter with a little girl who had just crossed the border after journeying from Guatemala by herself. There is a human dimension to illegal immigration, and O’Keefe does not ignore it.

However, there is also an impersonal dimension to this massive population transfer, and O’Keefe determinedly aims to uncover it – to put a face to the institutions and administrators that benefit from the rough injection of millions of people into American society. From government agents to bus companies to nonprofit resettlement groups to private contractors running huge, walled compounds housing thousands of children, O’Keefe doggedly tries to penetrate the mechanics of a system that resolutely hides itself behind a screen of silence, usually in the name of “safety” and “privacy.”

Some of the film’s more comical moments pertain to these segments, such as when the team follows some just-arrived Chinese migrants in San Diego to an employment agency, where other Chinese aliens, already in the country for several months, complain that it’s much harder to live in the United States than they had imagined. O’Keefe tries to sniff out a connection between the owner of the agency and more powerful actors, but it emerges that there really isn’t much going on; in fact, the owner asks O’Keefe if he knows of a way to apply for government grants.

Elsewhere, O’Keefe tries to get information about the operations of several huge residential centers for unaccompanied minors and tries to spin their refusal to give him access to the centers or submit to interviews as evidence of the existence of vast, government-funded child sex trafficking networks. But it seems more likely, though no less troubling, that the open borders policy of the last four years has created a tremendous humanitarian crisis of alien children roaming the continent by themselves, and the government is probably trying to keep them from becoming prey to sex traffickers while they sort out where to send them. Though O’Keefe does not uncover a salacious network of child predators, his vigorous pursuit of the truth does reveal the existence of a large, shadowy, government-funded, and lucrative system of child “welfare.”

So, “Line In The Sand” is correct in the larger sense that billions of dollars are being spent managing this human flow, and many people are getting rich off of it. The last thing these parasitical administrators of the nonprofit industrial complex want is for the border to close. O’Keefe does a great job of capturing in real time the corruption of a local New York City nonprofit called La Jornada, whose leader, Pedro Rodriguez, evidently perpetrates fraud, demanding fees for services that the city provides for free. O’Keefe also sends a Spanish-speaking reporter undercover into the Roosevelt Hotel, New York City’s main processing center for newly-arrived migrants, which offers him free housing, medical care, and even airplane tickets, even though the reporter explains that he has no identification of any sort. How, O’Keefe asks, in our post 9/11 security-obsessed era, are we to make sense of a system that admits millions of unvetted foreigners into the country, and then offers to fly them anywhere they care to go?

“Line In The Sand” is rough in parts, but intentionally so. Its subject is so sprawling and tangled that a neat and clean representation would be a lie. Even with a nine-figure budget – which this film assuredly did not have – a documentary about the border and the 30 million-footed human swarm that has crossed it would be messy and incomplete. But James O’Keefe and his small team have done something remarkable. They have taken on the decade’s biggest story, given it form, and preserved the humanity of its subjects. It is worth watching.

Seth Barron is a writer in New York and author of the forthcoming “Weaponized from Humanix.”

Tyler Durden
Sat, 12/07/2024 – 17:30