When I edited a magazine on digital innovation during the first internet boom, in the late 1990s and early 2000s, we had a motto: "Sometimes right, sometimes wrong, never in doubt."
In that spirit, I'm going to offer a judgment that goes against a lot of what I've seen in the press lately: I think the insurance industry will largely escape the crisis facing commercial real estate.
I realize that life insurers have $900 billion invested in loans for commercial real estate, or 17% of their investable assets, so they're not going to escape unscathed from the tumult that will play out for years, perhaps even a decade. But there are growing signs -- at least to my eye -- that they'll be able to avoid big losses to their portfolios.
I'll explain.
My argument is twofold.
First, there are signs that the market for commercial real estate is shifting from frozen-in-panic to rationality, and rational markets will work their way out of crises. Owners of office buildings seem to finally be facing up to how much the hybrid model will affect demand for their space and to whether they might, or might not, be able to convert their space to apartments or condos. Lenders are more comfortable making those calculations, too.
This recent Wall Street Journal article begins:
"Banks and other lenders are seizing control of distressed commercial properties at the highest rate in nearly a decade, a sign that the sector’s punishing downturn is entering its next phase and approaching a bottom."
The article continues:
"In previous downturns, comparable surges in foreclosure activity have signaled the approach of a market bottom. Once lenders seize a property, they are typically quick to sell it, a process that helps determine values of properties after long periods of sluggishness in the sales market."
Some of the results can be brutal. A Manhattan office building just sold at auction for 2.5% of the price it commanded in 2006. But at least people know where the market is.
Second, interest rates finally seem to be abating. Mortgage rates for homeowners hit a 15-month low last week, and the Fed is widely expected to finally start lowering interest rates next month. A key pressure point on commercial real estate is that $1 trillion of loans are coming due over the next two years. The current loans were negotiated during an era of roughly zero interest, so lots will be uneconomic in the current environment for interest rates. A long-awaited decline in interest rates will, however, diminish the pain.
Yes, a $900 billion position will be hard to unwind. Insurers will have to live in the uncertainty as rents for many buildings crater, as offices are revamped for today's workers' needs, as many are converted to living space, as interest rates decline, whether slowly or rapidly.
And, as I said up top, many think the reckoning for commercial real estate will be more acute than I do. Here are Harvard Business Review, Bloomberg and the Hill.
But if the commercial real estate crisis turns out to be far less acute for insurers than many expected, you heard it here first. (If I'm wrong, feel free to forget that you ever read this.)
Cheers,
Paul