{"id":145764,"date":"2022-11-28T11:09:43","date_gmt":"2022-11-28T18:09:43","guid":{"rendered":"https:\/\/www.biggerpockets.com\/blog\/?p=145764"},"modified":"2023-08-09T10:26:49","modified_gmt":"2023-08-09T16:26:49","slug":"ticking-time-bomb-in-real-estate-is-this","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/ticking-time-bomb-in-real-estate-is-this","title":{"rendered":"The Ticking Time Bomb In Real Estate Is Not Prices\u2014It&#8217;s This"},"content":{"rendered":"\n\n      <iframe loading=\"lazy\" frameborder=\"0\" height=\"200\" scrolling=\"no\" src=\"https:\/\/playlist.megaphone.fm?e=BIGPOC3717730218&#038;light=false\" width=\"100%\"><\/iframe>  \n\n\n\n\n<p><span data-preserver-spaces=\"true\">Are nightmares about the economy still keeping you awake at night? Well, the news lately has been fairly mixed. There are reports that prices won\u2019t fall as much and <a href=\"https:\/\/www.biggerpockets.com\/blog\/nar-economist-housing-prices-rise\" target=\"_blank\" rel=\"noreferrer noopener\">might even rise next year<\/a>, as well as reports of <a href=\"https:\/\/www.biggerpockets.com\/blog\/fannie-mae-is-preparing-for-a-downturn\" target=\"_blank\" rel=\"noreferrer noopener\">catastrophe<\/a>. Who\u2019s right? Who\u2019s wrong?<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">What I do know, though, is that there\u2019s a ticking time bomb in real estate. It\u2019s not housing prices or higher interest rates.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">It\u2019s throttled a credit market.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">The Ticking Time Bomb<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">Credit markets aren\u2019t as broadly followed and discussed as other economic indicators. We typically look at:&nbsp;<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Unemployment<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Interest rates<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Wall Street&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Housing starts&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Existing home sales and prices<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">But credit cycles can often have a greater impact than these widely followed and studied indicators.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">The Credit Cycle<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">The credit markets are extremely volatile. They can be wide open one day and slammed shut the next.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">When credit markets throttle down, it will likely impact residential and commercial real estate investments more than it will impact necessities like food and gasoline.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Credit cycles are significantly impacted by psychology. This is one of the reasons these cycles, and others like Wall Street, are so volatile and unpredictable. There is a human factor involved, and it\u2019s impossible for any investor, no matter how sophisticated, to accurately predict the future of credit cycles and, thus, the real estate market or the future in general.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Warren Buffett, Charlie Munger, Howard Marks, and others I consider experts are very clear in their opinion on this.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">The Impact of Credit Cycles<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">Capital must be available for maturing debt to be refinanced. Unlike residential mortgages, which often have a 30-year timeline, commercial finance matures in short timeframes. Commercial real estate debt, in particular, typically has a timeline of three, five, seven, 10, or up to 12 years.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Of course, there are a lot of real estate loans that were initiated several years ago that need to be refinanced in the coming months and years. As you can imagine, this could be devastating for these operators and their investors.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Unless income has significantly increased over the past several years, it\u2019s likely we will see a lot of defaults. Real estate foreclosures. Pain and suffering.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Yet, potential opportunity for well-positioned investors.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">I truly hope this doesn\u2019t happen to anyone. But in my decades in business, I have seen it happen over and over again.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Banks and other financial institutions are the sites of colossal mismatches in the need for capital. Banks have massive demand deposits that can be cashed in on a day-to-day basis. But they\u2019ve loaned that money (and much more) to borrowers who have long time frames, sometimes up to 30 years.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">This may cause financial institutions to be cautious in their lending, even when an economy looks generally healthy. I believe that is happening right now. Increased risk premiums built into many loans are some evidence. The throttling down of a lot of lending right now is more evidence.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Credit markets give off massive signals that create potentially devastating psychological impacts. It\u2019s a vicious cycle. Credit markets get spooked by economic news and throttle down. This throttling down causes more problems in the investment realm, including real estate and Wall Street. These problems cause further tightening, and\u2026you get the picture.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">An Overview of Credit Cycles&nbsp;<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">I often recommend one of my favorite books by&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.oaktreecapital.com\/\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">Oaktree Capital Investments<\/span><\/a><span data-preserver-spaces=\"true\">&nbsp;founder Howard Marks. It\u2019s called&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.amazon.com\/Mastering-Market-Cycle-Getting-Odds-ebook\/dp\/B078977BRM\/ref=nav_youraccount_switchacct?_encoding=UTF8&amp;qid=1665494537&amp;sr=8-1\" target=\"_blank\" rel=\"noopener\"><em><span data-preserver-spaces=\"true\">Mastering The Market Cycle: Getting the Odds on Your Side<\/span><\/em><\/a><em><span data-preserver-spaces=\"true\">.<\/span><\/em><span data-preserver-spaces=\"true\">&nbsp;It was published in 2018 as a follow-up to his fantastic earlier book,&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.amazon.com\/Most-Important-Thing-HOWARD-MARKS\/dp\/9353022797\/ref=sr_1_1?keywords=the+most+important+thing+howard+marks&amp;qid=1667509503&amp;qu=eyJxc2MiOiIyLjM0IiwicXNhIjoiMi4yOSIsInFzcCI6IjIuNDcifQ%3D%3D&amp;sprefix=the+most+impo%2Caps%2C112&amp;sr=8-1\" target=\"_blank\" rel=\"noopener\"><em><span data-preserver-spaces=\"true\">The Most Important Thing<\/span><\/em><\/a><span data-preserver-spaces=\"true\">.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Marks says that credit markets play a bigger role in the economy than most people would think. Let\u2019s look at signs of the two extremes in credit cycles.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">A Generous Credit Market<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">We have seen a generous credit market for the past decade or so. Many new real estate investors have only experienced generous credit markets. Good times! A rising tide that lifts all boats! Happiness, joy, and love all around! Money flowing like a river!&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">According to Marks, a generous credit market looks like this:<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Fear of missing out on profitable opportunities ?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Reduced risk aversion and skepticism ?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Reduced due diligence?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Too much money chasing too few deals ?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Willingness to buy assets in increased quantity ?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Willingness to buy assets of reduced quality ?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Relaxed loan covenants as lenders compete for debt?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">High asset prices, low prospective returns, high risk, and skimpy risk premiums ?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">A feeling that \u201cThings will get better forever!\u201d&nbsp;<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">Ironically, the worst of deals are done in the best of times! And that is what we\u2019ve seen for the past 12 or so years.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">But don\u2019t forget Warren Buffett\u2019s haunting prediction: \u201cOnly when the tide goes out do you discover who&#8217;s been swimming naked.\u201d<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">If you\u2019ve been swimming naked, now would be a good time to get your clothes on if it\u2019s not too late already. Sadly, I fear it is too late for many syndicators and commercial real estate investors. Perhaps some residential investors as well.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">The Other Extreme: An Uptight, Cautious Credit Market<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">It appears that we are entering, and have entered, an uptight, cautious credit market. This is a time when fear of loss comes to the forefront, and the desire for the amazing gains we\u2019ve seen this last decade takes a back seat. People suddenly remember again the fear of losing money trumps the desire for speculative gains.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">As it should! Remember, if you gain 50% on your investment, that is great news. But if you lose 50%, you must double your money to get back where you started. That often involves speculation, more risk-taking, and other bad practices that can land you in bankruptcy court.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Here is Mr. Marks\u2019s brief description of a cautious, uptight credit market:&nbsp;<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Fear of losing money?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Heightened risk aversion and skepticism ?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Unwillingness to lend and invest regardless of merit?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Shortages of capital everywhere?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Economic contraction and difficulty refinancing debt?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Defaults, bankruptcies, and restructuring ?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Restrictive loan covenants?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Low asset prices, high potential returns, low risk, and excessive risk premiums ?<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">A feeling that \u201cThings will get worse forever!\u201d&nbsp;<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">We could be heading into a time like this. It looks<\/span><em><span data-preserver-spaces=\"true\">&nbsp;<\/span><\/em><span data-preserver-spaces=\"true\">like some of these things are happening now.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">A Few Mini Case Studies<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">What do you think? Do you see evidence of a commercial real estate lending market tightening? I certainly do. Here are three points of evidence:&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">First, about a minute after economist Lauren Baker\u2019s presentation at BPCON 2022 in October, I asked<\/span><em><span data-preserver-spaces=\"true\">&nbsp;The Real Estate Guys Radio<\/span><\/em><span data-preserver-spaces=\"true\">&nbsp;host, my friend Robert Helms, what he thought of the presentation. He said he agreed a soft landing is certainly possible, but the recent tightening of the credit markets made him wonder if things would go south faster than the economist&#8217;s evidence might point to. He said he had already heard that from people he was talking to.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Second, I was on stage at the BiggerPockets Commercial Real Estate Forum the same afternoon.&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/users\/ajozz\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">AJ Osborne<\/span><\/a><span data-preserver-spaces=\"true\">, a respected self-storage developer\/operator, had some strong things to say about this topic. From the stage, he said that at least two banks he has long and trusted relationships with were significantly throttling down their lending. That equates to \u201cnot making commercial loans right now.\u201d He told the audience that this throttling of commercial credit availability could be the time bomb that undercuts everything else in this economy.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Third, I was recently at the Left Field Investors Meetup hosted by&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/users\/jimp2\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">Jim Pfeifer<\/span><\/a><span data-preserver-spaces=\"true\">. It was a great conference, and I saw some of you there. Rob Levy of LBX is a wonderful syndicator who invests in outdoor shopping centers. He reported a substantial decrease in lending for the retail space right now. LBX has a long, successful track record and can still get financing. However, he stated that he is still seeing a significant slowdown in commercial lending right now.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Just to be clear, a lot of this applies more to private banks, CMBS lending, and the like. Fannie Mae and Freddie Mac, which are charged with residential lending (mobile home parks, apartments, and residential homes), will continue to make loans through whatever happens in the economy. So if you are investing in those types of assets, and I know most of you are, you should still be able to get debt.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">So are you ok? Should you breathe a sigh of relief?&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Maybe not.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">If the economy does go into a tailspin (I\u2019m not predicting that), it could still significantly impact pricing, home sales, and all types of investments. If that happens, is all lost?&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">No! Remember Mr. Buffett\u2019s most famous saying: \u201cBe greedy when others are fearful and fearful when others are greedy.\u201d<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">There will likely be an upcoming opportunity to find deals that you have not been able to find over the past several years. A slowing economy could mean a great opportunity for many of us.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Howard Marks said that, ironically, while the worst of deals are made in the best of times, the best of deals are done in the worst of times! So, you may soon have opportunities you have not been seeing.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">What is soon? I have no idea, but if the Great Recession is any indicator, the best deals will probably not<\/span><strong><span data-preserver-spaces=\"true\">&nbsp;<\/span><\/strong><span data-preserver-spaces=\"true\">come in the coming year or so. Of course, the Great Recession may not be the best comp given the gravity of that crisis. We just can\u2019t tell. History doesn\u2019t always repeat itself, but it certainly rhymes a lot of the time.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Some Frightening News<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">One final note. This&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.fitchratings.com\/research\/structured-finance\/majority-of-maturing-us-cmbs-conduit-loans-can-refinance-03-11-2022\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">recent article<\/span><\/a><span data-preserver-spaces=\"true\">&nbsp;by Fitch Ratings sounds sort of upbeat if you\u2019re not reading closely. But check out this excerpted paragraph, which paints a pretty serious picture for many commercial real estate deals:&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">\u201cHowever, 23%, or $6.2 billion, of maturing volume would not be able to refinance under any of the scenarios. NOI growth averaging at least 1.5x current in-place NOI, or a new equity infusion that deleverages existing debt by at least one-third, on average, would be needed to pass the refinancing thresholds.\u201d<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">We\u2019re in a little bit of a pickle, to say the least.<\/span><\/p>\n\n\n\n<div id=\"hero-block_62ee867235a1c\" class=\"first:mt-0 hero-block py-4    has-background has-slate-300-background-color has-text-color has-slate-800-color\">\n    <div\n        class=\"gap-10 lg:gap-20 flex flex-wrap lg:flex-nowrap max-w-screen-xl mx-auto px-4 relative lg:items-center \">\n\n        <div class=\"relative z-30 lg:w-2\/3 \">\n            <main class=\"py-4\">\n                \n\n<p class=\"has-theme-slate-color has-text-color has-large-font-size\" style=\"font-style:normal;font-weight:800\">All the cash flow, none of the hassle<\/p>\n\n\n\n<p class=\"my-3 md:my-5 lg:my-8 has-theme-slate-color has-text-color\" style=\"font-size:16px\">Learn how to create financial freedom and passive income in real estate as a private money lender.\u00a0<em>Lend to Live<\/em>\u00a0makes passive income through private lending achievable for anyone. <\/p>\n\n\n\n<div id=button-custom-event-block_64138705d4d27 class='button-custom-event'>\n      <a href=\"https:\/\/store.biggerpockets.com\/products\/lend-to-live?utm_source=blog&#038;utm_medium=marketing_block\" x-on:click=\"window.analytics.track(&#039;Blog Block | Publishing: Lend to Live Book&#039;, {\n      referrer: &#039;https:\/\/www.biggerpockets.com\/blog\/ticking-time-bomb-in-real-estate-is-this&#039;,\n    });\" class=\" btn-shape inline-block no-underline has-background has-theme-blue-background-color has-text-color has-white-color\" target=\"_blank\">Get Yours Now<\/a>\n  <\/div>\n\n\n\n<div id=button-custom-event-block_641384b1eb1d8 class='button-custom-event'>\n  <\/div>\n\n            <\/main>\n        <\/div>\n\n                <div class=\"lg:w-1\/3 first:mt-0 relative h-full lg:flex lg:items-center\">\n            <img decoding=\"async\" class=\"object-cover w-full relative z-20 my-0  rounded-md hidden lg:block\" src=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2022\/07\/lendtolive-cover-scaled.jpeg\" alt=\"lend to live cover\" title=\"\">\n        <\/div>\n            <\/div>\n<\/div>\n\n\n<p><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Are nightmares about the economy still keeping you awake at night? Well, the news lately has been fairly mixed. There are reports that prices won\u2019t fall as much and might [&hellip;]<\/p>\n","protected":false},"author":214608,"featured_media":145765,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[4433,7119],"tags":[],"class_list":["post-145764","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-opinion","category-biggerpockets-daily"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/145764","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/214608"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=145764"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/145764\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/145765"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=145764"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=145764"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=145764"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}