by Peter Schiff, Schiff Gold:
The commercial real estate market is showing an “urban-doom-loop”, and Washington’s monetary policies are fueling the flames, pushing investors and banks to the brink. Will the government’s interventionist approach spark an economic catastrophe worse than 2008 that exposes the true cost of their reckless actions?
The following article was originally published by the Mises Institute. The opinions expressed do not necessarily reflect those of Peter Schiff or SchiffGold.
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Mainstream financial news today is replete with stories about “distress” in the commercial real estate market. But what is the precise nature of this distress, and what implications does it have for those outside of the respective industry or asset class? More importantly, what set of factors contributed to the distress, and what does that say about its potential alleviation?
Broadly, “distress” in the commercial real estate context refers to the inability of a property, or portfolio of properties, to make required payments on the underlying loan (to “service debt,” in industry terms). There is also physical distress—lack of physical upkeep, accumulation of deferred maintenance, etc.—but the inability to service debt is what’s generally referred to as distress in the financial media. I’ll refer to this as financial distress and focus on it as the more relevant driver of immediate and material negative implications for owners and investors.
In the following discussion, I’ll draw on my previous experience in the hospitality and core commercial real estate industry—specifically, my involvement in restructuring, recapitalization, and various other forms of dealing with financially distressed assets in the wake of the 2008–9 crash. I’ll also use my current role as the founder of a private equity real estate company focused on apartments to expound on the current issues in that specific industry. Throughout, I will highlight connections between financial distress and economic management by government at the expense of the free market.
Background
Murray Rothbard states in What Has Government Done to Our Money?, “Embedded in the demand for money is knowledge of the money prices of the immediate past.” If I want to buy a thing, I am keenly aware of that thing’s price (in money terms), which subsequently influences my demand for money. In a free market, in order to acquire that money, I must provide a service or good in exchange. Hence, the individual productive drive.
What the Federal Reserve and the United States government have done over the last fifteen years, and to a slightly less obscene degree for the last century, is to distort this relationship by creating money from nothing. Rather than demand for money and productive drive arising from a desire to acquire goods, the Fed sought to increase the desire to acquire goods (i.e., aggregate demand) by increasing the supply of money. As the money supply increases in this manner, only the first recipients of new money receive the primary benefit—the ability to acquire goods at status quo prices before they inevitably rise. This shifts the incentive from productive drive to rent seeking—the gaining of access and proximity to whoever controls the money supply.
After money is created, large banks and other financial institutions control its dissemination. The process of quantitative easing, for example, is facilitated by the primary dealers—a group of banks and hedge funds that are authorized to trade securities with the US government. Total money supply is also influenced by all banks through the fractional reserve banking system.
Since banks are in the business of investing and lending, the primary and immediate recipients of this new money are the capital markets—stocks, bonds, real estate, and others.
Source: compiled by author using FRED and https://www.greenstreet.com/insights/CPPI
To illustrate, from 2010–20, the money supply doubled, which led to a corresponding tripling of the stock market during that time, as measured by the Standard and Poor’s 500. This happened despite real wages growing by only 6.5 percent during this time—a complete disconnection of capital markets from the main street economy.
The Apartment Bubble
Lending to the commercial real estate market during this period of money creation was one of the ways for banks and other institutions to disseminate the increased money supply. This was already apparent in higher asset prices during the 2010–20 period, but the process was given rocket fuel in early 2020 when the Federal Reserve and the Trump administration created trillions of dollars ex nihilo in their panicked response to covid.
