Bank lending to the real estate industry could contract in the fallout from the collapse of Silicon Valley Bank and Signature Bank, according to Susan M. Wachter, Wharton professor of real estate and finance. Immediately, worries are running high over both the state of residential and commercial real estate loans advanced by the two failed banks, and the office space the two banks would vacate as they wind down operations. Those concerns were contained in the case of First Republic Bank, which also looked precarious until last Thursday when it secured a pledge of $30 billion in deposits from a group of 11 banks that included Bank of America and Citigroup.
“Banks are likely to respond to their investors’ distress by lending less, and this is not a good thing for real estate,” Wachter said last week on the Wharton Business Daily radio show that airs on SiriusXM. (Listen to the full podcast above). But with banks like First Republic being rescued and SVB’s depositors being made whole, the worst outcome — an economy-wide credit crunch — could be avoided, she says. On Tuesday, bank shares rose when Treasury Secretary Janet Yellen said that the government would take additional steps to shore up smaller banks if necessary.
Bank investors have grown anxious about real estate lending for two big reasons. First, as Wachter noted, regional banks have a disproportionately high exposure to real estate in their respective regions — the repercussions of a pullback in lending could be severe. Secondly, commercial real estate lending has turned unattractive with rising vacancies in the office space sector triggered by layoffs in the tech industry.
According to Wachter, if the economy goes into a recession, mortgage rates will fall. “That’s usually the beginning of a healing process, where buyers can come back into the market,” she said. But for that to happen, “we also need the underlying inflation rate to resolve, and that’s a bigger issue.”
This transcript has been edited for length and clarity.
Wharton Business Daily: How will the Silicon Valley Bank collapse impact real estate?
Susan Wachter: This is a troubling moment for real estate. Real estate, depending on the sector, is in a stress mode, particularly the office [space] sector. The overall economy looks like it will go into potential recession, and indefinitely slow down. This is obviously a moment where interest rates are key, and lending is key. But now that the [real estate] sector is in most distress, the banks are likely to respond to their investors’ distress by lending less, and this is not a good thing for real estate. The worst case is a credit crunch with potential consequences for the overall economy.
Wharton Business Daily: What would be the impact on the real estate industry of SVB filing for Chapter 11 bankruptcy protection?
Wachter: Silicon Valley Bank is not a real estate-specific entity, but it affects Silicon Valley specifically and tremendously. But there are others out there that are potentially at risk. And that’s the concern. For example, First Republic Bank is very much exposed to real estate, and real estate is exposed to First Republic Bank. And in general, the whole regional sector of banks is disproportionately the lender to local and regional real estate markets. So, it’s the regional banking sector that is at most risk at this point. From that channel, real estate now faces yet another hit.
Wharton Business Daily: Is the exposure to the real estate market part of the reason some banks are coming together to give support to First Republic?
Wachter: Absolutely. It’s through real estate that even the very largest banks are at risk — not only to real estate, but the overall economy. Real estate is hit hard, and that’s going to be another real risk [leading up] to a potential recession.
Impact on Commercial Real Estate
Wharton Business Daily: Is there one segment in real estate that’s more affected than the others?
Wachter: Yes, absolutely. It is commercial [real estate] that’s [most] affected. Commercial real estate includes multifamily housing. The real estate industry is a huge sector in the overall economy, as well as an asset for the banking system. So, we’re in this potential doom loop, which we’ve seen before. But hopefully it will be stymied, and the various rescue missions will in fact stabilize the banking sector — and therefore, it will not lead to the worst case for real estate, which is a credit crunch.
Wharton Business Daily: Can you explain why it is that the commercial real estate market seems to be comfortable working with the regional banking sector for a lot of its financing?
Wachter: It’s efficient. It makes tremendous sense, because real estate — [even with] national and global capital flows — is really regional and local. So, for efficient lending, the lenders need to have a good eye on the prospects for their sectors — the future of the sectors, their capital needs, the risks. And the regional banks have done a tremendous job at this, so they’re extremely important for that ecosystem of efficient lending, and efficient production of real estate. If the regional banks are at risk, it’s not only a short-term credit crunch risk, which is serious, but it’s also a longer-run risk to the ecosystem of lending. This is a very large country, and it needs to have those regional eyes on it.
Wharton Business Daily: If many investors prefer safer options, that may leave real estate out in the cold.
Wharton Business Daily: I suppose we also have to look at markets like Seattle and San Francisco that may see a lot of the real estate impact because of the dependence on the technology sector.
Wachter: Absolutely. They’ve twice been hit — by the overall slowdown, and interest rate increases. But of course, the tech implosion is hitting these markets. But now, on top of that, their lending sources are about to close down. That said, SVB and Signature Bank will go on in some way or form, and there will be lending into these markets. But nonetheless, this is not a good thing for the West Coast market that’s already very hard hit.
Wharton Business Daily: And I guess the other side to it is, it was an interesting landscape for commercial real estate to begin with. When you think about the impact of coming out of the pandemic, companies are reassessing their mix of office space. The question that builders face is how much they ought to invest in future projects.
Wachter: Yes. Well, the office apocalypse is absolutely the case for the West Coast. The West Coast/San Francisco markets are really hard hit. And this makes it worse. The East Coast has smaller office markets, which do have a future.
Wharton Business Daily: We saw mortgage rates actually tick lower [last week] as well. What scenario are we looking at there?
Wachter: Well, it’s a bit of a glimmer of a silver lining. Of course, if the economy goes into a recession, mortgage rates absolutely will go down. And that’s usually the beginning of a healing process, where buyers can come back into the market. But in this case, we not only need to have mortgages tick down by one percent or so, we also need the underlying inflation rate to resolve, and that’s a bigger issue.
Wharton Business Daily: How much do you think this would impact the Federal Reserve’s decisions around interest rates in the next week or so? And then, what would be the downstream impact on the real estate market?
Wachter: Absolutely, [this would be] front of mind [for the Fed]. The Fed actually has three missions. Monetary stability [or managing] inflation, is the first. [Promoting the goals of maximum] employment is the second mission. But there is [also] the [goal of] overall financial stability — right now, that’s what is at most risk. They’ll definitely have eyes on [it as they make future interest rate decisions].
Wharton Business Daily: What are you watching most closely in terms of real estate in the short term?
Wachter: [What I am watching] most closely is the banking sector, which is now the critical factor for real estate markets. The fact that the largest 11 banks came together to infuse $30 billion into First Republic is an extremely good sign. It is a very good move, because it recirculates capital, which is flowing right now to the big banks and in the end will help the big banks. The regional banks are where the real estate sector goes first for loans, [even as] there are other sources of lending for the real estate sector overall. We also need to watch the overall economy.
Wharton Business Daily: On a scale of one to 10, where’s your level of concern about all this impact on real estate?
Wachter: It does depend on the sector. The office [space sector] is definitely in the crosshairs. Single-family and multi-family will be the first to recover if we go into a slowdown. The good news is that the single-family mortgage market actually is in safe hands, and it’s stable. That is where my focus is, because that’s Middle America. That’s all of our resources going forward, in terms of our children, new people trying to get homes, et cetera. That, fortunately, is a stable component of the economy at this moment. But still, [mortgage] rates are too high.