In the classic movie Ghostbusters, Gozer the Destructor appears in the form of the StayPuft marshmallow man, and the end of humanity is narrowly avoided thanks to the high-risk maneuvers of the ghostbusting adventurers.
In the stock market, the form of the Destructor changes with frightening regularity: For much of last year, it was inflation and rising interest rates. A few weeks ago, it was the social media-manufactured banking crisis.
And now there’s a new Destructor allegedly wreaking havoc on the economy. But all it’s actually doing is giving us a great profit opportunity…
Each form of the Destructor has a kernel of truth, which varies in size. Inflation and rising rates have been an issue for stock prices and may well continue to be a problem. The kernel in the banking collapse was smaller, but it dominated the headlines and market activity for a couple of weeks.
As soon as that passed, the Destructor assumed a new form: commercial real estate (CRE).
As with the other recent Destructors, there is some truth here. Higher rates can be a problem for commercial real estate. Morgan Stanley’s chief investment officer, Lisa Shalett, pointed out in a recent report that office properties were facing a wall of refinancing this year at much higher interest rates.
The report also speculates that more than a trillion dollars of office-related debt will need to be refinanced over the next 24 months. Shalett goes on to suggest a peak-to-valley trough for commercial real estate prices of 40%.
Morgan Stanley is not the only firm talking about potential problems in office markets. For example, Joan Solotar, the global head of private wealth solutions at Blackstone (BX), recently told Bloomberg that traditional office in the United States is much worse than most people think.
She also said that Blackstone’s real estate fund had reduced its holdings of U.S. offices to just 2% of assets and focused on stronger segments like data centers, warehouses, and single-family rentals.
While I am in complete agreement as to the difficulties facing the office market in the U.S., I will point out that the Destructor appears in the financial markets every few months with world-ending predictions, and yet with the exception of those who overleveraged or ignored valuations, most of us are still here.
Those who rush to name the latest form of the Destructor almost always leave out a few details, and in those details, there are opportunities.
In the internet bubble, the Destructor’s disciples left out the fact that when the markets collapsed and weak companies ceased to exist, the stocks and bonds of those tech companies that were strong enough to survive represented a life-changing opportunity for massive profits. And in 2009, almost no one was talking about how high the price of surviving banks and other financials could climb as the Great Financial Crisis ground to a close.
I hear a lot of people talking about how the regional and community banks have a lot of commercial real estate loans on the books. I hear very little discussion about how low loan-to-value ratios are for these loans. And I hear even less about how low the percentage of total commercial real estate loans are center city office loans in community banks portfolios.
Does anyone think that a bank in Youngstown, Ohio, with branches located, for the most part, in small midwestern towns, is exposed to New York or Chicago office towers that will have refinancing and occupancy problems?
The bank is more likely to have exposure to office buildings full of local accountants, financial planners, brokerage firms, realtors, dentists, and insurance agencies—people who have been back in the office for a long time. Their rent is current, and their mortgages will be paid.
And yet the shares of smaller banks with pristine loan portfolios with little exposure to the riskiest part of commercial real estate are priced like they bet it all on Midtown Manhattan offices.
No one is talking about the fact that an office building in Tampa has different characteristics than one in Chicago. Sunbelt office real estate is doing more than just fine—it is booming. If a current owner struggles to refinance, willing buyers are waiting.
Everyone talks about Joan Solotar’s comments on offices. I hear very little about her comments on where Blackstone is investing capital.
Real estate investment trusts (REITs) that invest in data centers, apartments, and other strong segments of the commercial real estate markets have seen their prices decimated in the past year despite strong and improving fundamentals.
The form of the Destructor has been chosen: It is commercial real estate.
As is always the case, those who are overleveraged or ignored valuations will suffer enormous pain.
Those patient-aggressive investors who recognize that every step the Destructor takes sows the seeds of massive opportunities will be in a position to collect outsized profits.