How Washington and the Fed Caused the Commercial Real Estate Crisis

The financial distress in the commercial real estate market, specifically the inability of properties to make required loan payments, can be traced back to government intervention in the economy and the financial sector. According to Artis Shepherd, as explained in his audiomesis wire narrated by Million Quinteros, this financial distress is a significant issue with material implications for owners and investors. Shepherd, who has experience in the hospitality and core commercial real estate industry and currently runs a private equity real estate company focused on apartments, argues that this distress is a result of government actions that undermine the free market. Rothbard's theory, as mentioned in "What Has Government Done to Our Money," explains that individuals demand money based on their knowledge of past prices, and in a free market, they must provide a good or service in exchange. However, when the government intervenes, distorting prices and disrupting the market, it can lead to financial distress in industries like commercial real estate.

The Federal Reserve and the US government have artificially increased the money supply over the last 15 years, leading to a disproportionate benefit for the financial markets and a shift in incentives from productivity to rent-seeking. This process, facilitated by primary dealers and fractional reserve banking, primarily benefits the capital markets, leading to asset price bubbles like the one seen in commercial real estate during the 2010s and the apartment market in the early 2020s. The creation of trillions of dollars in response to COVID-19 accelerated this trend, resulting in the widespread use of bridge loans and a disconnection between the stock market and the Main Street economy.

During a period of easy access to high leverage floating rate loans, apartment prices saw a dramatic increase, leading to unsustainable projections for returns. Inexperienced speculators and syndicators filled the gap left by experienced operators and investors. Cap rates dropped to historically low levels, but relied on assumptions of no interest rate increases and significant increases in net operating income. However, these assumptions proved to be incorrect, and when benchmark interest rates did increase, financial distress ensued. This resulted in foreclosures and dilutive debt restructurings, causing significant losses for initial passive investors. The apartment bridge loan market, estimated to be around $80 billion, is experiencing approximately $27 billion in financially distressed loans, resulting in substantial losses for investors.

The commercial real estate market is experiencing significant financial distress across various sectors beyond just bridge loans. Commercial mortgage-backed securities, office properties, retail establishments, and hotels have all been impacted by the COVID-19 pandemic and resulting economic downturn. Office properties have been particularly hard hit due to the shift to remote work, making meaningful recovery unlikely. Distressed office properties in major metros have even sold for pennies on the dollar. Retail and hotels, while also suffering losses, have not faced the same fundamental issues as office space. Smaller owners in these sectors have been disproportionately affected. Additionally, over $2 trillion in commercial real estate debt is held by regional banks, which directly incur any related losses and must offset these losses with otherwise useful capital. As losses accumulate, banks become susceptible to failure or regulatory seizure.

The ongoing banking crisis is likely to continue without significant intervention, as government bailouts and loose monetary policy have contributed to asset bubbles and subsequent bursts in the past. The commercial real estate market is just the latest example. Pressure from politically active groups within the banking and investment industries for lower interest rates to alleviate asset price declines and regulatory threats only perpetuates the cycle. However, more loose money does not solve problems caused by loose money in the first place. Government interference in the economy ultimately rewards those who didn't earn it at the expense of others. To avoid continued economic crises, it's crucial to let the free market operate without state and Federal Reserve interference. For more insights on this topic, visit Mises.org.