CEO confidence/The stress of CRE will only continue, some math/ECB pushback/Company comments of note

The Conference Board's Q1 2024 CEO Confidence survey reflected some mixed messages. While the headline print of 53 finally got back above 50 from 46 in Q4, "23% expect to lay off workers, up significantly from 13% last quarter" and "35% of CEOs said they expect to expand their workforce over the next 12 months, down slightly from 38% in Q4 2023."

The bottom line from the report, "CEOs are feeling better about the economy, but remain cautious about risks ahead." Moderating inflation and expectations for lower interest rates were the two main reasons for optimism. 

The wounds from exposure to US commercial real estate is not just coming from New York Community Bank and Aozora in Japan, Deutsche Pfandbriefbank, or PBB, a German real estate lender yesterday announced that they added to their loan loss provisions blaming "persistent weakness of the real estate markets" and referred to the current situation as the "greatest real estate crisis since the financial crisis." The stock is down 18% this week.

There is going to be a lot more of this in 2024 as unless the Fed is cutting interest rates back to zero and the 10 yr yield collapses, there is no way many landlords are going to be able to avoid the pain of a loan resetting to 8-10% from 3%, no matter the real estate. It doesn't have to be just office that gets squeezed if one has an offsides balance sheet. 

Let's do some quick math. If someone purchased a piece of real estate in 2021 for $20,000,000, regardless of the type, at a 4.5% cap rate and financed 70% of it, they put down $6mm in equity and borrowed $14mm interest only at 3% for 3 years. So, $900k in gross income was more than enough to cover $420k of interest expense when the deal was penciled. On the assumption that the loan is due this year, an 8% interest rate on that $14mm would equate to $1.12mm in interest expense. Even with 5% annual rent growth increases, the rental income comes to $1.04mm, below the new interest expense bill and before any other expenses are paid like property taxes, insurance, property management, and utilities. Also, on the refi, if the cap rate is now 6%, that implies the building is only worth $17.3mm instead of $20mm and we know some office is marked down even more. 

Bottom line, there is a lot more pain to come in commercial real estate for those whose balance sheets are too levered and debt is coming due this year.