Thursday, July 25, 2024

No Commercial Real Estate Bailouts

In the mid-2000s, small-town Minnesota resident Charles Marohn saw an upscale strip mall being built in a neighboring city. By 2020, the mall was still half-vacant. It was a clear signal that supply had exceeded demand. Yet just as the pandemic began to recede, Marohn saw another, even larger mall go up on an adjacent property.

It violates all the laws of common sense, but it’s the norm across much of the United States. Many of us have seen evidence of the commercial real estate industry’s “if you build it, they will come” mindset firsthand — the large empty office buildings, unused business parks, and blank storefronts. Now, it has Wall Street spooked.

“I see a tsunami of loans coming due,” one CEO recently told CBS. “It’s really the perfect storm,” said another. “You could see a run on all small regional banks. … And that could put us back to where we were with the financial crisis of ’08.” Other real estate insiders are already calling for “some sort of intervention or assistance from federal regulators or a bailout from elected officials.”

On the one hand, the fact that our financial class is willing to admit the error of its ways is an improvement over the days leading up to the Great Recession, when real estate investors indulged in delusions of never-ending profits until the bill finally came due, and responsible homeowners were left to pick up the tab.

On the other hand, the “experts” should have seen this coming years ago. Other people did. For instance, locals sounded the alarm on commercial real estate glut in Washington, D.C., as far back as 2017. Of course, that didn’t stop developers from erecting new buildings in the nation’s capital, which still has vacancy rates above 20%.

Vacant properties, the work-from-home revolution, rising crime in urban centers, the unaffordability of city housing — all of these factors and more should have made it obvious that commercial real estate was approaching a cliff. Instead, there was unfounded optimism that things would return to “normal.” Owners used an “extend and pretend” strategy to get to the next monthly payment or quarterly earnings report. The façade only came down with the failure of Silicon Valley Bank.

That failure was a stark reminder that things can and do fail, and that investors in failed businesses can be wiped out. That’s the way the real world works. Unfortunately, the financialization and consolidation of our economy have disconnected our markets from reality. WeWork and private real estate investment trusts — some of which are now blocking investor withdrawals — are among the clearest examples of this, but they are far from the only examples.

Take the case of the Minnesota strip mall. If the developer had sought financing for the project from a local bank, it probably never would have gotten off the ground. But as Marohn writes, “[i]f the local bank has any involvement today, it is [typically] as a broker — getting paid to make the transaction happen and then selling that commercial loan onto a secondary market.” In other words, financial constructs are disrupting local market feedback.

We have created an economy in which large-scale investors only realize they’ve gone wrong when it’s too late to turn back. This proved devastating to middle-, working- and lower-income Americans in 2008, who suffered a historic economic downturn while those “too big to fail” were bailed out by Washington. Unfortunately, history may be repeating itself.

If the Biden administration protects investors from the consequences of their actions, as the Federal Reserve let slip it would do in March, it will essentially be transferring wealth — at a massive scale — from America’s working class to the very investors and laptop liberals responsible for this crisis. That would tear our social fabric to shreds and further expand our class divide.

As policymakers, our duty is to the common good, not the stock market. Whether we like it or not, our economy is in the midst of a massive transformation. There will be winners and losers, but bailing out commercial real estate investors isn’t in our national interest. In fact, it would be the definition of unjust.

This article was originally published by RealClearPolitics and made available via RealClearWire.