John Fish, CEO of Suffolk Construction and Chair of the think tank Real Estate Roundtable. David L. Ryan/The Boston Globe via Getty Images
The commercial real estate market is in a slow-motion crisis, driven by the dual burden of higher interest rates and lower demand for office space as a result of the Covid-19 pandemic.
John Fish, CEO of Suffolk home builders, chair of the think tank Real Estate Roundtable and former chairman of the Federal Reserve Bank of Boston, took to the What Goes Up podcast to discuss the sector’s woes.
Below are some highlights of the conversation, summarized and edited for clarity. Click here to listen to the full podcast.
Q. Can you talk to us about why this rise in interest rates that we have seen is so dangerous for this sector?
A. When you talk about these big buildings, especially in New York City, you see all these buildings out there, almost a hundred million square feet of empty office space. It’s breathtaking. And you say to yourself, well, right now we’re in a situation where these buildings are about 45%, 55%, 65% occupied, depending on where they are. And suddenly, the cost of capital to support these buildings has almost doubled. So you have a double whammy. Utilization has gone down, so value has gone down, returns are down, and the cost of capital has gone up exponentially. So you are in a situation where the timing has had a significant impact on the development industry.
The biggest problem right now is that capital markets are frozen across the country. And the reason they’re frozen is because no one understands the value. We cannot rate the pricing as very few assets traded during this period. Nobody understands where the ground is. So unless we have some sense of pricing, we won’t bother with it.
What I would tell you now is that the light at the end of the tunnel came only recently, in June, when the OCC, FDIC and others in the federal government issued policy guidance across the industry. And I think this political orientation is very, very important for a number of reasons. First, it shows that the government is taking a leadership role on this issue, because it’s this issue that people don’t want to touch on because it can end up being really carcinogenic. It also provides guidance and support to the lender community and borrowers. And now there is clarity.
In essence, what they say is similar to previous troubled debt restructuring programs. They say, listen, any asset out there where you have a qualified borrower and a quality asset, we enable you to work with that borrower to ensure you can restore the value that once was in that asset itself. And we grant you an extension of 18 to 36 months, basically “do it and extend it”. What happened in 2009, on the other hand, was more of a long-term forward-looking proposal that really had an impact on SIFIs (systemically important financial institutions). This policy alignment is actually aimed at the regional banking system. And why I’m saying that is because the SIFIs don’t have really large real estate debt right now, probably less than 8% or 7%. While regional banks across the country probably hold over 30% to 35% and some as much as 40% of book inventory in real estate right now. So these guidelines at least gave the good assets and the good borrowers a chance to remedy the situation at the end of the day.
Q: This “stretching and pretending” notion strikes me as almost a derogatory phrase people use for this type of Fed leadership or this type of approach to solving this problem. But is that the wrong way of thinking? Is “stretch and pretend” actually the way to get us out of this mess?
A: Let me say this: I think a well-known financial guru said that this is not essential for the overall economy. And I’m not sure if that’s the case. When I think about the impact this is having on the regional banking system, essentially the US suburbs, we saw the Silicon Valley Bank die, Signature Bank die, and First Republic die. If we have a systemic problem in the regional banking system, the unintended consequences of that could be catatonic. Also, what happens when real estate values go down? 70% of all income in cities in America today comes from real estate. So when you suddenly start lowering and foreclosure on these buildings, the financial tap stops, doesn’t it? Suddenly, tax revenues are falling. Well what happens is you talk about firefighters, police officers and teachers in Main Street, USA and at the end of the day we’ve never seen anything quite as tumultuous as this. And we have to be very, very careful not to tip over the building, which we think is really stable.