January 2020 we were making considerations for our office lease which was expiring May 30, 2020. We had committed to taking on additional space, increasing our rent overhead by 50% and hiring 2 to 3 new team members. This “seemed like a good idea at the time”. As time moved on through January and February, we had chosen additional space, determined the necessary tenant improvements we would “want & need”, President Trump was being impeached and there was news of a deadly virus spreading through China & Europe.
As march was upon us it became clear that this virus was going to have a meaningful impact on people and businesses in the near future. With pressure from the landlord to sign a long term lease, we decided to “take two aspirin and wait”, to see what happens. My lease wouldn’t expire until the end of May and the worst that could happen, is that I could extend for 6 months to a year.
In April we found that vacancies in commercial office space was becoming more and more available, big landlords stuck to their guns hoping that this will pass quickly and they would have leverage in negotiating leases in the near future. We waited and we began shopping. Over the next six weeks, we were able to find comparable, larger space for a third of the price as the market was collapsing. We were able to leverage that position with our landlord to achieve a short term 3-year extension, including $50,000 in tenant Improvements, 6 months free rent and 4 reserved parking spaces. Cause & effect are not equal in time and space, sometimes the best strategy is to simply “take two aspirin and wait”.
Since that time our 300,000 square foot class A office building has about 20% occupancy. Large companies have sent their employees to work from home. One tenant moved in in January, taking 30,000 square feet with at least $500,000 in tenant improvements, only to move out in March and they haven’t returned.
As COVID 19 cases continue, there is hope & promise for a return to something resembling normal in the middle of 2021. But, the commercial real estate sector may never return to normal and will have a meaningful effect on the banks that finance them, especially small community banks.
Many banks have heavy concentration in and are dependent on commercial property lending. Banks hold half of all commercial real estate loans. Small community banks are heavily concentrated in commercial real estate lending as are large banks.
Problems in commercial real estate can hurt banking in a couple ways with loses on existing loans and will reduce future lending volume, both having a negative effect on earnings. Neiman Marcus and many major retailers have filed for bankruptcy. Hotel occupancy is down over 30%, airline capacity is down 60% from 2019. This isn’t good. Apartment rent levels have collapsed in large cities including Los Angeles, San Diego and San Francisco. Shopping malls have been devastated, not to mention single purpose restaurant buildings.
Some of this pressure will be temporary. Recreational and business travel will recover gradually. College graduates will get tired of living in their parents’ home and eventually move out boosting recovery in the apartment rental markets.
But some permanent shifts are beginning to emerge. Online retail shopping went to warp speed this year causing severe problems for traditional retail properties. Many companies, as is happening in the building we lease, are looking hard at their office space needs and concluding that they need much less of it. Banks are reducing their branch networks as consumer behavior and mobile banking becomes more accepted, I believe that this will be a permanent change.
It isn’t all bad news. Businesses like Amazon have prospered, boosting demand for warehouse and distribution space. Industrial REITS are up, even though these property types demand much lower rent than office and retail.
Typical commercial properties financed with 75% to 80% loan to value ratios could not absorb a 30% reduction in market value before being “underwater”. A downturn in some specific properties will be temporary, and some “underwater” loans won’t become total losses. But how many retail, office and lodging properties will be so fortunate in the long run?
Today banks appear to be in good shape, and their large commercial real estate exposure is not yet a problem. But I believe that at least a few challenging years lay ahead. Many community banks will weather the storm. Unfortunately, not all will be so lucky.
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Contact:
ALLIANCE PORTFOLIO
120 Vantis Drive #515
Aliso Viejo Ca, 92656
Info@allianceportfolio.com
(949) 349-1322
http://www.allianceportfolio.com/
Real Estate Broker
California DRE
License #: 02066939
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Alliance Portfolio is a Leading Full-Service, Private Hard Money Lender in California.
We serve borrowers who have unique situations that do not meet strict institutional guidelines while providing investment opportunities that are well secured and well underwritten with desirable returns on investment capital. Our services include private equity finance, hard money loans, bridge loans, fix and flip loans, cash-out financing, quick close loans and second mortgages on single family real estate, multifamily real estate, commercial real estate, light industrial, cannabis and land properties in California with an emphasis in hard money loans and private hard money lending in Orange County, Los Angeles, San Diego, San Jose, San Francisco, and the surrounding bay area.
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