There is $2 trillion of commercial real estate mortgage debt coming due over the next two years. Given the low values and occupancy of much of these holdings, it’s assumed there will be a “commercial mortgage apocalypse” as a result. In this Self-Storage University podcast we’re going to review this event and where it currently stands.
Episode 111: Is The "Commercial Mortgage Apocalypse" Really A Hoax? Transcript
Back in 1999, on December 31st, we all sat on the edge of our seats because we were told by supposedly great learned mathematicians and technology experts that the world was gonna end at midnight, they said the computers could not roll over the digits. So they said the year 2000 would cause perhaps the end of civilization as we know it. They projected we would have a complete collapse of the power grid. We might have nuclear war over the simple fact that computers could not read the date of 2000. And there was even a name given to this, which is called Y2K. And the concept was simply that we were all doomed to going back to a 100 gatherer society perhaps when the clocks rolled over and we hit the year 2000. And yet it never happened. We all sat there, we were all worried. And what happens? Nothing.
So it became January 1st, 2000. And with every minute that passed, the world did not end. And we've been told recently about another horrible situation called the commercial mortgage apocalypse. And just like Y2K we're told it could end the world of real estate financing as we know it. And it's also built on some scientific fact, which is simply there's about $2 trillion of commercial mortgages which are coming due over the next couple of years. So is it gonna happen? Are we gonna have the meltdown? Are we gonna have the commercial mortgage apocalypse? Well, let's dig deeper into that concept. Now, there's no way to get around the fact that there is $2 trillion of debt coming due. That's a simple addition issue. Just take all the properties coming up, all the loans coming due and add 'em together. And yeah, it's around $2 trillion. It's a huge amount of real estate and we know that a lot of those sectors are gonna have horrible trouble. The worst of it is office. Everyone who drives through any downtown in America can probably notice it doesn't look like it used to.
Nobody out on the streets. If you drive by at night, very few lights are out in the office buildings, and that's simply because there's nobody there anymore. Even the US Federal Government Office holdings right now are only 25% occupied. All those giant buildings in Washington DC that hold all the various departments, they only have 25% of them with actual people in them. It's a chronic issue. So in the case of office, retail and hotel holdings, the vacancy has never been worse. We all know you can walk through almost any regional mall in America today, and there might be anywhere from a third to 50% of it vacant. So that part's just a fact. And then we have the fact that the cap rates in America and the cap rates, the underpinnings of how you value properties, those have risen substantially since Q1 of 2022 when the Fed took their short term Fed funds rate from 0.25% to 5.75% in just no time at all. As a result, cap rates went up and all real estate holdings, not just office and retail and hotel, but even self storage were hugely damaged. So at the same time that we've got massive vacancy in many properties, we also have the additional strain and burden of these high interest rates all then coming due at the same time.
The largest office building in St. Louis is a 1 million square foot building at one time called the AT&T Tower. It's made of kind of a reddish granite built in the 1980s. And that building sold recently at auction for less than $4 million. It cost about a $100 million to build it back in 1980s. That's a pretty big hit. There was also recently about a half a million square foot regional shopping mall that sold for around $7 million, just like that office building, it probably cost a $100 million or so to build it originally. Those are the kind of losses that will wipe banks completely off the earth. They can't handle losses that big. And yet it's just a fact. It's just science that we have 2 trillion of these things barreling down the highway and it's all gonna have a very poor ending. So the underpinnings of the commercial mortgage apocalypse are very, very real.
But then why hasn't it happened so far? It hasn't happened for basically two reasons. Number one, these lenders do not want to acknowledge these enormous losses. So instead they engage with what's called extend and pretend. Extend the maturity date farther out and pretend it will all work out fine. Just keep getting those payments in every month if you can, and kick the can down the road and and bankers think, well, if I kick it, the can down the road long enough, maybe I won't even be at the bank anymore. Maybe I can retire before all of this comes due. Now, banks have engaged often in extend and pretend, they did a lot in 2007, 2008 with the Great Recession. It's just human behavior. You don't want to take the bad news.
You'd rather delay it thinking, well, maybe it'll change. Maybe the cap rates will go down. Maybe the occupancies will go up. Who knows? The internet killed office occupancy. It killed retail occupancy. Maybe there'll be a sudden swing away from the internet. We are seeing some stores that are reporting the fact they may go back to brick and mortar because they're just tired of all the returns, all the hassle, the uncertainty of selling strictly online, but yet probably not enough to really help things much. Also, banks think if I extend it long enough, maybe the interest rates will turn. Maybe they'll go back down again. We've already seen Jerome Powell drop the interest rates a little bit.
What if that accelerates? But then there's one more piece missing in what triggers such things as the commercial mortgage apocalypse, and that's the bank regulators forcing them to actually write down those losses. That's the missing piece in the puzzle. If you look at the FDIC and what's known as the Texas Saving Loan crash from 1987, 1988, that's what caused the crash. The banks are more than happy to do, extend and pretend. That's just human nature. Of course you're gonna do that. We all procrastinate on our homework, so you can't blame them for that. But then what happened is the government sent in bank regulators who refused to let them extend and pretend. They said, "No, you can't extend and pretend this loan, this property's only worth half of your loan and we demand that you write down half of it right now." And if so, doing they cause all those banks to fail.
So it wasn't just the fact that the things were due, it was that the government made them acknowledge those losses. So when is that going to happen? That's the part we don't know. Now with the incoming Trump administration, we know that there will probably a lot of loosening of bank regulations, and that may save the day here. It's possible that the banks will never have a swarm of FDIC agents and bank examiners show up and say, "Oh, well you've gotta reclassify all this debt as bad debt" "Uh-oh. Now your bank doesn't meet the minimum capital requirements." So it's possible we could skirt the issue to some degree, but the problem is it's unlikely those values will ever come back. Those office buildings, shopping malls, big hotels, they're never gonna recapture their glory. They're never going to get back to being full. They're never gonna get a big rent.
So it really is kind of hopeless. It's just perpetually kicking the can. So what's it mean if you're looking at self storage facilities? It means be very, very careful on what happens in the debt world. If you have a loan that's coming due you, I'd renew it now. I wouldn't wait longer. We just don't know what's gonna happen. And if you're buying a property, I try and put in the longest loan you can humanly get so you can weather whatever that storm may be. None of us really know what the end result will be of the commercial mortgage apocalypse. We don't know if it will happen. We don't know when it will happen. But like any good boy Scout, you wanna be prepared. You wanna acknowledge its existence and make smart moves based on that. This is Frank Rolfe, the Self Storage University Podcast. Hope you enjoyed this and talk to you again soon.