The Azucena Take: Debunking the Misinformation About the Investment Real Estate Market
Following the collapse of Silicon Valley Bank and Signature Bank, the news media has been inundated with headlines predicting more bank failures. Unfortunately, many of these stories have been misleading or clickbait designed to cater to a sense of doom and gloom. The most prevalent among these reports are those claiming that investment real estate will be the primary cause of the next wave of bank failures.
This flood of misinformation has the potential to cause panic and fear among investors, which is why it's important to address the most common inaccuracies and provide a more accurate perspective. Knowing the reality will help an investor to avoid making a decision based on fear.
Fake News ≠ Misinformation
Before delving into the details, it's important to clarify that we are not suggesting that the information being published is fake news. The issue at hand is that many media outlets lack the expertise needed to fully understand the intricacies of the banking system and investment real estate market. As a result, when a study is released, the reporter may have misinterpreted it due to a lack of knowledge or experience. Other times they might look to a report that was published by questionable or unqualified sources.
It's also worth noting that some media outlets rely on tapping into readers' emotions, using clickbait headlines that focus on doom and gloom, even if the main article doesn't live up to the hype.
Misinformation and Reality
Myth: Small Banks Hold 70% of Investment Real Estate Loans
This misinformation is based on a dubious misinterpretation of a research paper. What a few journalists did was calculate the debt held by domestic banks that are smaller than the 25th largest bank. According to the original study, small and mid-sized domestic banks hold only 67% of all investment real estate loans.
While a few percentage points might not seem significant, it's important to consider the type of bank involved. In the United States, there are over 4,746 banks (not counting local and regional credit unions), so defining the bank size can have a big impact. According to the original study, small and mid-sized domestic banks hold 67% of all investment real estate loans, not 70%. However, when looking at all investment real estate loans, banks only make up 40% of the market, with the rest held by government-sponsored enterprises, private investors, and life insurance companies. In comparison to other institutions, small and mid-sized banks only hold 27% of investment real estate loans (as of 2022).
Truth: Small and mid-sized domestic banks hold 27% of all investment real estate loans.
Myth: A Wave of Investment Real Estate Loans are Going to Default
If you have been following our previous posts on property performance, then you are aware that most properties have been performing exceptionally well. Since 2020, apartment vacancy rates have remained at an average of 3%, while demand for storage and industrial spaces has increased significantly. Retail and hospitality sectors have bounced back in 2021 and now face the challenge of finding adequate staff to meet the surging demand. Office space, on the other hand, has been underperforming, but it has shown an improvement since 2022.
Understanding the current mortgage market is crucial alongside property performance. Approximately $270 billion to $397 billion in debt held by banks, out of a total of $450 billion to $728 billion, is due to come due in 2023. Most of these loans were issued five years ago, during a period of historically low interest rates and conservative underwriting standards, while the properties securing these loans have likely appreciated in value. However, in the event of a 30% or more drop in property values, the average borrower is likely to default on their mortgage.
There are also several factors that will determine if a property is in distress. The key factors are:
When the loan was written
When the loan will mature
How much equity is in the property
Truth: There is not going to be a wave of mass defaults. Most of these properties were purchased 5 years ago and most likely appreciate in value.
What it Means for Investors
The key takeaway is that relying on clickbait articles is not a substitute for genuine research. These articles are often created to generate ad revenue or written by individuals who lack industry and market knowledge. To make informed decisions, it's best to consult with a reputable expert who understands the market and is not driven by sensationalism or fear-mongering tactics.
The Azucena Take provides an inside look into the investment real estate market using the research done and data collected by Marcus & Millichap