Self Storage University Podcast: Episode 99

Getting Ready For The Commercial Lending Apocolypse

There is around $2 trillion of commercial real estate loans coming due in the next two years, and there’s an anticipated $1 trillion of losses when those loans renew, thanks to the terrible performance of office and retail properties. And most of this financial catastrophe will fall upon regional banks that may well fail and send the entire banking industry into a freefall, similar to what happened in the Texas Savings & Loan crash of 1987. In this Self-Storage University podcast we’re going to explore what the “commercial lending apocalypse” is all about and how to insulate yourself from the potential impact.

Episode 99: Getting Ready For The Commercial Lending Apocolypse Transcript

There is a huge issue brewing right now in commercial real estate. It ties back to the office sector and the retail sector, there's big high-rise buildings and that local shopping mall, and they're titling this, "The Commercial Lending Apocalypse". What's happening is there is $2 trillion of real estate loans coming due this year and next year, but they think there may be as much as a trillion dollars of loss in those loans, they think many of those loans will lose 50 cents on the dollar.

This is Frank Rolfe, the Self-Storage University Podcast, let's explore the phenomenon of the commercial lending apocalypse, what that will do to the self-storage industry and how to prepare for the basic eventuality of this occurring. So here's what's happened, many of your loans out there, particularly on office buildings and shopping centers tend to be about 10 years in length. So if we roll the hands of time back 10 years, so now we're back into the 2014 era, what was going on then?

Well, one thing was interest rates were insanely low, so the Federal Funds Rate was about 0.25 versus about 5.5 today, but additionally, this is before the advent of COVID, and also before the ongoing momentum of the internet. So people still went to offices, they didn't work remotely, and they still bought things from stores because they didn't do all their shopping on Amazon and other online vendors. And then what happened? Well, suddenly here comes COVID. And the internet, of course, in the background is always spinning throughout the whole process, and suddenly we don't go to offices any more, people work remotely, and then suddenly we don't buy things in retail brick and mortar stores anymore, we buy it all online.

So what do you have? You have massive vacancy in office buildings and shopping malls, you also have lower rent because with supply and demand when there's no demand the price goes down. And now 10 years later, those loans are coming to at the worst possible time, we have the highest interest rates in 40 years, and we have the weakest demand for office and retail space in American history. So all over the nation, office vacancy, for example, and some cities is running as high as 25 to 40 percent and this office buildings were built on a vacancy allowance of only typically 5%, so probably every high-rise building you see as you drive around is insolvent. The debt is greater than the value of the building.

And you probably know just from going out to the mall, how bad things are in that regard. Your typical mall today has got maybe 30% of all the stores empty. And then sometimes they try and fake that with pop-up shops or doing other things creatively in the store front, so you can't see how empty it is, but malls typically also have a free fall in value. How bad is it? Well, in St. Louis, Missouri, they recently sold the tallest building in St. Louis, 44 stories in height, built in the 1980s for three-and-a-half million dollars. That's probably a loss so though no one really knows, no one knows the exact amount of the loan from the bank. But it's estimated that loss it's probably gonna be around $100 million. And then you had a large 300,000 or so square foot shopping mall that recently sold for seven million dollars, which was again, probably another $100 million loss.

Doesn't take many of those $100 million losses until you've really pushed your way on to that one trillion loss estimate. And what will happen if the banks truly lose a trillion dollars, it'll start causing banks to fail, it's thought that most of that debt is in the hands of regional lenders. Good old regional banks, they cannot handle losses of that magnitude. If you look back to the Texas savings and loan crash back in 1987-1988 there were 3,000 banks that failed during the Texas S&L crash. America went nuts recently when three banks failed, multiply that times a thousand and you start to see the magnitude of what could happen with this coming apocalypse. So then what can we do to prepare for this pending banking crisis?

Well, if you have an existing self-storage facility, the first thing you better do is you need to start bonding with your banker better, because if you have a good bond with your bank you have a much better odd of getting your loan renewed. Because when the banking apocalypse occurs, a lot of banks are not gonna wanna make new loans, and those who are already on the books at the bank and in good standing with the bank, have a much greater chance of pulling off for renewals. So how do you bond with your banker? Talk to them, call them, if you're local, go have lunch with them. Many people get a loan and then they just forget the bank, they just ignore them and don't have any further contact until the renewal comes up, it's not a good idea. What do you do when you call for your renewal and you get told, "Oh, I'm sorry, he's not with the bank anymore."? That wouldn't be a very good day for you. Another thing you can do is if you have the ability go ahead and refinance now, don't wait for the apocalypse, just go ahead and refinance now ahead of it.

Most of the damage has not been felt yet, it'll be felt towards the end of this year, and then a whole bunch of it by the end of next year. So now is not a bad time to go ahead and renew the loan if you still can. Also if your debt comes due within the next two to three years, I would start now, well ahead of when it comes up, to get new debt. That gives you a lot of time to try and find a bank. And if you miss it, if your timing is bad and you hit the apocalypse, at least it gives you some time to potentially try and sell the property off even. But give yourself plenty of runway to make sure you don't get into any kind of a term default situation.

Also, if your loan is typically a million dollars or more use a loan broker. The loan broker is a very, very important piece of the equation, because the loan broker knows who's still making loans and who's not, and that could be very very important to you. Often, there are loan brokers who have knowledge of banks, even in the worst of circumstances, banks that will make loans on storage facilities with extreme vacancy or in more rural markets. And you could get the loan if you only knew who they were and you'll never figure it out in time, the loan broker gives you a much improved learning curve. So using a loan broker might really, really help you. You might also prepare by thinking about a capital partner or someone to help if to get the loan renewed you have to put even more money in because there's now a lower loan-to-value. Real estate in the past was at loan-to-value of 70 to 80 percent, but we're now seeing loans that are falling down to more along the lines of 50%.

Also do your best, if you can, to go ahead and push as hard as possible to improve your occupancy if you can, and try and get your NOI as high as possible before that renewal, because that'll help give the bank insurance that it can go forward with it. Now, if you don't already have a storage facility with a loan on it, then this crash may help you because when banking gets tough, it filters all the way down through all real estate channels and typically is going to drive values lower. So it may allow you to buy something of good quality at a much lower price just because the timing of the apocalypse. There also maybe new opportunities or self-storage facilities which come on the market through distress because the owner cannot find a loan or retain a loan, so that may actually help you.

You know, the famous steel Baron, William Kaiser, the founder of the American steel industry, once said that "problems are only opportunities in work clothes". Which means, and even in the worst storm, in the worst recession and even in this banking crisis, there will be a silver lining for those who are smart, who navigate it properly and use it to their advantage. There's always a silver lining in every storm, and the key is to understand what that lining is and how to get there. And despite the fact that there's a commercial lending apocalypse coming upon us, like a giant giant tornado or a hurricane, there are some proactive steps you can do to minimize your risk and potentially even come out of it better than you started. This is Frank Rolfe, the Self-Storage University Podcast. Hope you enjoyed this. Talk to you again soon.