Although the regional banking troubles that engulfed the commercial real estate sector this past March appear to be calming down, attorney Jason J. DeJonker said he doesn’t believe the problems are over just yet and that another bank failure isn’t out of the question.
“Office is still incredibly different. We are seeing decreases in value, even in major cities, that range from 25% to 75%.”
DeJonker, a partner at the global law firm Bryan Cave Leighton Paisner, also said he still sees lingering valuation problems in the office sector and he worries about these financial difficulties spreading to other areas of commercial real estate. Scotsman Guide recently spoke with DeJonker about his outlook for the banking sector and where commercial real estate is headed in the near term.
What is the current state of bank lending for commercial real estate projects?
I have never seen banks so unwilling to lend, frankly. And it’s not just banks — it’s all financial institutions. Both banks and nonbank financiers have been very cautious in advancing funds. At this point, the only transactions we see with any degree of regularity are in two categories: either rare and very high interest rate construction and development deals, or insurance company transactions where the loan-to-value (ratios) are so low and the asset classes are the types that even insurance companies are willing to advance funds on a loan.
In general, we are just not seeing a lot of activity, whether it’s retail, hospitality, office or multifamily. We also are seeing an unwillingness for banks and other financial institutions to lend in the health care space, whether it’s skilled nursing, acute care or assisted-living facilities. Those types of loans are very difficult to refinance right now.
What is the status of the banking crisis, and do you expect more regional banks to face financial problems or a possible collapse?
I think it is definitely a possibility. At this point, all it takes to create a run on a bank is a few bad articles and a decrease in stock price. The depositors will move their money out very quickly. I can tell you just from speaking with banks that there has been significant damage done to the number of accounts and the amount of money that is being held in those accounts in many regional banks. So, we are not out of the woods by any stretch of the imagination.
We also have not had any rightsizing of real estate values as it relates to some commercial real estate loans originated by regional banks. If there are any dramatic adjustments in values resulting in significant write-downs by some of these banks, it could get messy. It really will depend on whether certain banks have trouble maintaining their account bases and have significant exposure to nonperforming loans.
What valuation changes are you seeing?
It depends on the asset class. For the most part, hospitality has largely bounced back, although “work-travel” hotels continue to see difficulty versus vacation hotels. There are some outliers, but the value of hotel properties has stabilized. Office is still incredibly different. We are seeing decreases in value, even in major cities, that range from 25% to 75%. Everything is getting hit to some extent. It really depends on the city and the type of office property you are talking about. For instance, if you are looking at a Class B property or lower, you are seeing significant drops in value because there isn’t the market for new tenancies in office space. For those owning B- and C-level properties, it’s very difficult.
The last thing I would add is, people are talking about converting these buildings to multifamily properties. Those conversions are ridiculously expensive and many of the building floor plans won’t work. One major impediment is that some of these buildings have only one washroom on each floor. They don’t have water systems running everywhere and many of the buildings have low ceilings. You might be better off tearing some of these properties down and building something else there.
Is there something that will potentially signal the market reaching the bottom for the office and banking sectors?
I don’t know what the sign will be. But I don’t think we’ve gotten to the bottom yet as it relates to some of the valuation issues that we’ve talked about. I am concerned that we are going to see more softness in other asset classes that we haven’t seen yet. For instance, we haven’t seen the amount of turnover in the multifamily properties. In secondary markets, the rents on newer construction, in certain instances, have gone up considerably in recent years. People are paying rents based on a COVID-19-inspired economy with very low unemployment. I don’t know if the market can support such high rents because I don’t know if the incomes and rents match up any longer. ●