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By now you have undoubtedly read about the failure of Silicon Valley and Signature Banks. Like most disasters, there were a lot of factors that came together to spell the demise of these two institutions. Some are blaming rising bond prices, others the crypto crash, and others deregulation for the crashes. But if we had to pick one thing that really pushed these banks into trouble it was too much exposure to one industry.
Silicon Valley Bank was focused on startups, particularly those with VC funding. When things started to look shaky, those depositors started leaving en masse and a liquidity crisis ensued. The fall of SVB then caused a run on Signature Bank, which had a similar focus on one industry, crypto. With too many eggs in one basket, the banks were unable to pay back the deposits that people were asking to pull out, being as much of that was already in the hands of borrowers or invested.
Controversially, the Federal government has stepped in to help depositors recover their money but has announced that it will not do the same for investors. We will likely see more regulations come from this that will limit a bank’s exposure to one industry and require more cash reserves. But even before that happens investors in banks will probably force banks to diversify their operations. While these particular bank runs were caused by an exodus of depositors, losses on investments can also have the same effect. That means banks will be less willing to lend money to one particular industry as it might take the bank down with it if there are mass defaults. That means banks may pull back from lending on commercial real estate.
Recently large banks have already been pulling back from commercial property. Luckily for the industry, those gaps have been filled by smaller, regional banks and special servicers. These regional banks will likely see more regulation about how much they can lend but even if they don’t they will probably be pushing to deleverage from commercial property and diversify into other industries.
If you look at the list of the banks with the most commercial real estate loans it has most of the nation’s largest banks, but there are a few exceptions. One example is New York Community Bank. They were the seventh biggest lender to commercial real estate in 2022 but are only the 35 largest banking institutions. Another example of a bank that has focused on commercial real estate is the Bank of the Ozarks. The small bank has become one of the most active lenders for commercial development by focusing a whopping 42 percent of its total loans on construction.
Going forward these banks will not be as willing or able to pursue their strategy of focusing on one one sector. That pullback will be another blow from commercial property borrowers, who already have spiraling interest rates to deal with. The silver lining is that this failure might make the Federal Reserve think twice about raising interest rates again, as it might expose more banks to this kind of failure. But even if rates don’t get raised, the banking sector still sees a lot of risk in commercial property and risk isn’t something that most banks are interested in taking on right now.
Banks are not only concentrated by industry at times, they can be very geographically focused as well. Here is a great map showing the most popular bank in each state:
There are fears that other, larger banks could face a liquidity crisis. Credit Suisse in particular has seen its shares tumble as its largest investor, Saudi National Bank, indicated that it would not provide more cash to prop it up.
Broke and broken
An interesting new study just came out from the Federal Reserve Bank of New York that shows something that the real estate industry has known for a while but the general public likes to forget: the main cause of poorly maintained apartments is broke landlords.
As predicted, regulators are already outlining new rules for mid sized banks that could make them have liquidity thresholds and regular stress tests like some of the largest banks.