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August 16, 2024Original Analysis

CRE Doom Loop: Rate Cuts Can’t Fill Office Buildings

With the expectation of an interest rate cut soon, commercial real estate stocks are up. But while lower interest rates might kick the can down the road, they can’t fill empty office buildings — so they won’t end the post-COVID CRE doom loop that could trigger a banking meltdown.

All that has happened is that market manipulation expectations are driving real estate stock prices up, but without the underlying support — i.e., actual renters in commercial buildings, so that owners pay back their loans to overexposed banks. With empty buildings not collecting revenue, no hope of filling them, and trillions in loans due to mature soon, the CRE market is a ticking time bomb.

REIT Index, 5-Day Chart

Source

A report from real estate giant CoStar noted that in New York City, the office market value is back to the same levels as before COVID, even with a record-high number of vacant commercial buildings. And buried in the report is a criticism of the Department of Finance’s finding that CRE’s market value is up:

Some industry professionals said at the time the department’s market value data, which affects how buildings are assessed and taxed, may have used building owners’ outdated income and expense reports.”

If the value of these buildings is based on outdated data from owners who want to make their real estate portfolio look more valuable than it really is, how bad is the problem? We’re not really allowed to know the answer. In their 10-K filings, publicly-listed banks only have to list the historical value of their collateralized loans rather than the current market value. As explained by Shivaram Rajgopal in Forbes:

“Meaning, we do not know how much of these loans are likely to be recoverable once the potential deterioration in the value of the collateral is considered.”

For banks with high exposure to commercial real estate, lower interest rates might buy them time, but that’s only shoving the proverbial beach ball further down beneath the water. Once it slips from their grasp, it will burst from the surface with even more force, and cause a bigger implosion than if the band-aid were ripped off now.

But that’s impossible, because there is no free market. If interest rates were being set by market forces instead of a small group of appointed representatives for a banking cartel, interest rates would remain much higher for much longer — and overexposed, overleveraged banks with commercial real estate loans would be allowed to fail.

The Fed is determined to cut as soon as possible, citing cooling inflation. But in reality, inflation is still hot, but the Fed has no choice but to cut rates to prevent these commercial real estate lenders from going bust.

Besides, the real inflation numbers are much higher than what gets reported officially, giving the Fed a manufactured justification for rate cuts regardless of the economic reality. As Peter Schiff said on his recent Peter Schiff Show podcast episode:

“You always take the CPI with a grain of salt. In fact, if you want to get a more accurate measure, just as a rule of thumb, double whatever number the government reports, and that’s probably a lot closer to the actual number.”

And it isn’t just commercial real estate — the housing market is in trouble as well. Government intervention and inflation is making home ownership, and the costs associated with insuring and maintaining houses once they’re bought, totally unaffordable for Americans. While politicians like Elizabeth Warren blame the problem on a “housing shortage” and on the Fed for interest rates being “too high,” making borrowing unaffordable, this is exactly the kind of intervention that fuels inflation, market bubbles, and devastating busts to begin with.

Peter explains the real core of the issue:

“The real reason that housing is unaffordable now is because of the government…it’s the government that has driven up the cost of housing…so if there’s a scarcity of houses, it’s because the government has done something to prevent the free market from solving that problem.”

The government can’t stuff renters into office buildings without any occupants. But the Fed can lower interest rates, desperate to prop up a doomed market, and send inflation spiraling further out of control. They’re damned if they do and damned if they don’t — but they work within an academic ivory tower, isolated from the devastation they cause to average struggling Americans.

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