Real Estate… A Canary in the Coal Mine?

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Most of us can remember 2008 when we went through a crisis – a perfect storm of multiple aspects of the financial system collapsing at the same time which caused the Dow Jones Index to drop by 50% and the economy to endure an 18-month recession. The consensus is that the housing market was to blame for the recession, specifically bad loans handed out to finance homes that should not have been purchased. People who didn’t have the income to support high mortgage payments were given low interest rates in order to qualify for lending and when these loans started to go bad, it had a ripple effect across the financial markets. Many investment firms had investments that were filled with these bad loans and took major losses. Other firms that were selling insurance on these investments defaulted as well, which magnified things even further. We all know what happened after that: the government decided that bailing out the companies to stabilize an incredibly fragile financial system was worth the risk.

Fast-forward to 2020 and the COVID shutdown; this created dramatic changes in the workplace. Working remotely was previously considered a luxury benefit and became the new norm for most employees, while production levels stayed relatively normal over the next few years. With the new work environment, employers found they no longer needed such big workspaces and many downsized or even stopped having a physical workspace, giving them a huge cost savings. In almost all cities, “For Lease” signs are the new normal, as tenants have become scarcer. This shift also has allowed employees to move to less urban areas and save significantly on rent; but this caused massive nationwide home price increases, specifically outside of large U.S. cities. Home values increased at a rapid pace – up almost 40% in the past three years.*

This has all come to a grinding halt with the Fed drastically increasing interest rates over the past 11 months, causing the housing market to completely dry up due to high interest rates. But what has become of these commercial buildings now sitting at low capacity or even empty? Are we beginning to see some cracks form in the real estate world?

Some real estate investment trusts (REITs) have begun to freeze movements out of their funds given various liquidity issues. What is beginning to happen is some of the underlying assets in these funds are now being valued significantly lower than what they have been in previous years. This is especially true in private REITs (those exempt from SEC and not traded on major exchanges). Given that they have fewer rules to follow, they are the first ones beginning to feel the withdrawal challenges as one of the world’s larger firms, Blackstone, announced limits on withdrawals from the $69 billion private REIT.

Will this trickle down to the retail investor world, or will the rules put in place from the last financial crisis help prevent further damage? No one can say for sure; but given the current real estate market, it feels like we may see more headlines about REITs coming down the pike and the real estate market in general. Could we see a repeat of 2008 when the real estate market was the first domino to fall?

* statista.com/statistics/275159/freddie-mac-house-price-index-from-2009/#:~:text=The%20Freddie%20Mac%20House%20Price,rates%20in%202020%20and%202021

** cnbc.com/2022/12/08/blackstone-chief-defends-real-estate-fund-amid-rush-for-withdrawals.html.

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