Wall Street analysts like Morgan Stanley think commercial real estate may be the next “Big Short” in the same way housing was. In fact, some hedge funds have begun to place bets on a coming collapse in real estate, reminiscent of the financial crisis. But instead of betting against housing, this time they’re going all in that the CRE market collapses. The following charts explain why:
A Collapse in Department Store Sales
Although commercial real estate prices are above the highs they set before the housing crisis, malls and retailers haven’t been as fortunate. The reason is that malls rely on big retailers such as J.C. Penney and Macy’s. With falling sales, retailers are closing at the highest rate since the 2008 financial crisis.
Source: Bank of America
2016 Department Store Closings the Highest Since 2008
Most malls depend on at least one big retailer. When an anchor store closes, foot traffic drops, which in turn hurts other retail occupants. According to Morningstar Credit Rating’s estimates, roughly 40% of the loans due this year won’t be paid. Commercial real estate prices have been on the upswing since 2009, but increasing vacancies have caused prices to stagnate.
Source: Credit Suisse
Commercial Real Estate Prices May Have Peaked
New rules came into effect in December requiring banks to hold at least 5% of their loans on their books, which has caused a slowing of loan growth.
A number of retail analysts expect about one-third of US malls to close in the coming years.
Source: Green Street
But Don’t Throw in the Towel Just Yet…
Remember – analyst calls are only estimates, that could end up being too conservative. For example, if commercial real estate investors become more willing to accept lower returns or if the industry’s need for financing turns out to be lower than estimates, these predictions may be overblown. For example, Blackrock thinks U.S. commercial real estate recovery has room to run.
They see US commercial real estate delivering attractive total returns with interest rates still relatively low. While capital appreciation may slow, Blackrock sees the potential for property managers to add value by upgrading buildings.