The consequences of Silicon Valley Bank’s (SVB) collapse due to a liquidity crisis were evident to everyone. SVB had allocated its available capital into long-term investments, resulting in insufficient liquid funds to meet the demands of its depositors.
What’s scary, though, is that there is an even bigger crisis on the horizon that no one is talking about — and it might require you to think very differently about how you conduct due diligence on your bankers.
Shrinking Office Space
The coming crisis will be driven by the rising popularity of working from home. While many organizations have resisted this trend for years — “working from home” was often synonymous with not working — the pandemic changed the game completely. Suddenly, people realized they could be more productive working from home while avoiding their daily soul-crushing commutes.
That is especially true for people who live in and around major cities like New York, Chicago, and Washington DC, where traffic is prodigious. Rather than spending hours each day shuffling between home and the office, millions of people have opted to work from home instead.
This shift in where people prefer to work has a cascading impact on the kinds of office space companies will need now and into the future. Many organizations with Class A office facilities now forecast that they need only half or less of the space they previously had. If they once leased four floors of space, they might now need only two. Many tenants would have pruned their office space if it wasn’t for the long-term leases they signed in the pre-pandemic years. We have advised clients to reduce their office space for a few years.
But those leases will eventually expire. And when they come up for renewal, that’s when the trouble is going to start.
A Looming Liquidity Crisis
It used to be that commercial office space was considered a safe investment. That’s not going to be true anymore. As renters scale back on the amount of space they rent, their landlords will find themselves in a tough spot. If they find that they can only rent half the floor space in the building, they may not be able to cover their mortgage payments. Worse, the value of the business is directly related to the rental rolls. Half the rent means the building is worth half as much.
That will force the banks who loaned the money to those landlords to step in. But their problem will be that that building value is now half what it used to be. The bank can’t sell the building and cover their mortgage. That means they’ll face a massive liquidity crisis like the one that took out SVB.
This scenario is exactly like the 2008-09 banking crisis that devastated the residential real estate market; only this time, it will be driven by commercial real estate.
This looming disaster will unfold in slow motion as those leases expire over the next few years — and many banks will soon be in financial trouble.
Making the Switch
As a business leader, this coming banking crisis means that you must think differently about your relationship with your bankers. We’re all used to being poked and prodded to the Nth degree by banks before they’ll lend us money. Now, it’s time to flip the tables on that model. It’s time for you to put your banks to the test to understand how exposed they are to Class A real estate, especially in major inner-city areas.
Your goal is to understand what risks your banks are exposed to in commercial office real estate and to make the switch to a safer lender before the crisis happens.