Three (Potentially) Sobering Credit Realities
Aside from higher mortgage rates, there are indirect issues that could eventually catchup with commercial real estate. But it’s not all bad news.
By Erik Sherman
Credit rating agency KBRA put together a list of a dozen aspects of credit as macroeconomic pressure waves continue to race about the country and globe. No mention directly of commercial real estate, but CRE sits in a context of an overall economy, and some of the dozen factors they mentioned could have ultimately an indirect effect on the industry.
First, the wealth effect. Decisions as any marketer can tell you is always in large part emotional. And consumer financial confidence has fallen. Even though most of the value of U.S. stock holdings are in the hands of the wealthiest 10%, people freak out when they see retirement savings getting hammered. “And now, we are just starting to see softness in consumers’ second largest asset, residential real estate, which was down 0.6% in July from the June level, according to the Federal Housing Finance Agency (FHFA) national home price index,” the report said. That could cause retail spending to start falling, which means retail property owners have to stay alert.
Next, defaults. If indeed the country is going to hit a recession as the effects of interest rates expand over time, default rates could rise. They’ve averaged 12% in the last three recessions, excluding the pandemic one. KBRA expects any downturn to be shallow. “Consumers are sitting on savings roughly 50% higher than pre-pandemic levels, and their net worth, notwithstanding the aforementioned hit from the downdraft in the equity markets, is 24% higher than it was coming into the pandemic,” the report said. And, for now, the jobs market is strong. Corporate margins are at 50-year highs and many companies paid down debt since 2020. So, maybe things won’t be all that bad, KBRA calculates. Which would be good because defaults, for CRE, are bad. Companies that had leases and paying them no longer do.
However, FedEx had an earnings warning, which is bad. Unlike some other earnings warnings, it wasn’t about higher costs. “FedEx certainly has its share of operational and strategic issues, but we have a sense that this is also what normal looks like, a post-pandemic return to a more typical environment, one not supercharged by stimulus,” the firm wrote. “One where cost pressures are very real and geopolitical issues create headwinds for multinationals.”
The biggest issue may be volatility and financial stability. Many businesses, definitely in CRE, took advantage of leverage and low rates. But now conditions are changing, and many could experience a fast drop rather than a steady right upward. Plus, the dollar is too strong. “The U.S. Dollar Spot Index (DXY) has reached its current level (113 as of September 30) just two other times in the past 50 years: during the WorldCom/Enron-driven recession in 2000-01 and in the wake of Paul Volcker’s unprecedented rate hikes in the early 1980s,” KBRA says. “It’s not good for financial stability.”
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