Remember, this is commercial real estate … so it’s not like the housing market where you can get a 30-year mortgage and ride out a few declines along the way. Here’s a typical scenario in the NYC office market:
1. A major real estate player buys an office building in 2019 for $100 million.
2. A major commercial lender appraises the building at $100 million, based on it’s then-current lease revenue.
3. The lender allows a maximum loan-to-value ratio of 75%, so it extends a commercial loan to the buyer for $75 million on the property.
4. Within one year, disaster strikes in the form of COVID idiocy and general mismanagement by government and corporate leaders. The NYC office market is in shambles, and the office building that was worth $100 million in 2019 is now worth only $60 million today.
5. The commercial lender notifies the property owner that the $75 million (or close to it) loan balance now exceeds the value of the property, and the real estate player must now come up with a large cash payment just to keep the loan current.
6. Real Estate Player says: “I don’t have $15 million on hand right now. Can we renegotiate the loan terms?”
7. Commercial Lender says: “$15 million won’t be enough even if you pay it today. See Paragraph X of your loan agreement, which is the 75% maximum loan-to-value provision. That means you have to pay the loan down to $45 million, not $60 million, on the $60 million property. Please send us $30 million within the next 60 days.”
8. Real Estate Player: “Forget about it. I don’t have $15 million, let alone $30 million. Here are the keys to the building.”
9. Commercial Lender: “No worries. We will take the building that is now worth $60 million, and we will file a claim under our credit default insurance policy with Big Insurance Company cover the remaining $15 million.”
10. Big Insurance Company: “Good luck collecting on that insurance claim, Commercial Lender. We have $25 billion in insurance reserves but we are facing $100 billion in credit default claims. We filed for bankruptcy in the U.S. District Court in New York City yesterday.”
And that is how your 2022 financial crisis begins to unfold.
Then what does Joe Biden say to Big Insurance Company?
That’s what reorganizations are for. Long as you keep government bailouts out of the picture, the players will work things out. New investors will take over and the properties will not be over-leveraged. Rents will come down (unless the owners prefer to manage vacant properties) and the well be less over-building. It doesn’t have to be a crisis (unless, once again, government gets involved).