FA Magazine June 2023 | Page 24

and 2019 , the average default rate on high-yield bonds was 2 %. “ For the preceding 30 years , it was about 4 %,” he continued .

Americans lulled into complacency by the airport walkway are now confronting a sharp reversal in financial conditions . As Jim Grant of Grant ’ s Interest Rate Observer notes , it was only three years ago , in 2020 , that Fed Chairman Jay Powell argued that the central bank “ needed to make up for a shortfall in inflation .” At least that mission was accomplished .

An Office Crisis ?

At present , commercial real estate sits at the epicenter of the financial fear machine as Americans appear to be going everywhere but back to the office . The future of offices is now the subject of ongoing debate in numerous conversations , including Berkshire Hathaway ’ s recent annual meeting . Optimists like Berkshire CEO Warren Buffett remarked that office buildings are not going away . His more skeptical vice chairman , 99-year-old Charlie Munger , who began his career in real estate , responded by saying that the owners might well be gone , however .

Munger is just one of several observers warning that office properties and property assets are likely to become an ongoing source of trouble . He recently told The Financial Times that while he doesn ’ t expect a replay of the financial crisis , “ A

Liz Ann Sonders observed that , when it came to the disconnect between the Fed and the financial markets , the Fed is likely to keep rates higher for longer than market participants are hoping . markets are already reflecting this new circumstance . “ The commercial real estate industry in dollars is about $ 20 trillion ,” Boockvar said . “ The public REIT part is only $ 1 trillion ,” and public RE- ITs , he added , already have fallen about 30 % plus in value .

The remaining $ 19 trillion resides in private markets . “ I do not believe that they have yet to acknowledge reality , with [ the ] Blackstone REIT being a perfect example of this new world we ’ re in ,” Boockvar continued . “ The private REIT market is more at risk here when it comes to real estate generally . Actually , some public REITs look pretty attractive after the big downdraft .”

That glass-half-full view of commercial real estate is shared by Rick Gable , the portfolio manager of a $ 3 billion REIT fund at MFS Investment Management . He compares today ’ s problem in office buildings to that of shopping malls a decade ago , when the online shopping phenomenon started to gain momentum .

Today , Gable estimates that 70 % of shopping malls remain viable . The other 30 % have their own issues — anchor tenants like Kmart often top the list . But most occupy decent real estate , often in suburban intersections , and the properties can be repurposed . lot of real estate isn ’ t so good anymore . There ’ s a lot of agony out there .”

One of the points that Marks and Munger make is that a lot of challenged businesses , not just offices , enjoyed extremely low-cost debt that needs to be refinanced in the next few years . This is also true in the opaque private equity space and the shadow banking system . It includes numerous private investors in the advisory business , for that matter .

As Grant says , it ’ s not just a problem for regional banks with commercial real estate loans . Interest rates depend on inflation and inflationary expectations , and a consensus is building that the 1.5 % world of the last decade was an abnormality . Peter Boockvar , chief investment officer of Bleakley Financial The " Fed Put " Exits Group , told attendees at Mauldin ’ s event Another constant for the last 35 years that a 3 % to 4 % rate was more likely in has disappeared in the last year — and the next decade . In early 2021 , no company was factoring a 5.0 % increase in it willingness to intervene in financial

that ’ s the Federal Reserve Board ’ s tac-

interest rates into their five-year plans , markets when stock prices swoon . This Boockvar said . had provided an implicit floor for the

Now higher cost structures arising from deglobalization are becom- “ Fed put .”

equity market . It came to be called the

ing a permanent part of the landscape . Starting with the 1987 stock market Boockvar pointed to the estimate of crash , continuing through the Thai baht Taiwan Semiconductor ’ s CEO , who said and Long-Term Capital Management it was probably five times more expensive to build the company ’ s new giant in 2008 , market participants could rely

crises in the 1990s and the housing crisis

manufacturing facility in Arizona than on Fed Chairman Alan Greenspan and on the Asian island , as an example . his successors riding to the rescue when

Debt-dependent businesses — and governments — will have to allocate more Based on the central bank ’ s behavior

equity prices started to tumble . capital to interest expense , and public Continued on page 56

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