The past year has been volatile for commercial real estate, between ever-escalating interest rates, pending debt maturities, questions of an economic downturn and inflation. The Aug. 30, 2023, Walker Webinar focused on these issues as presented by Walker & Dunlop’s Chairman and CEO, Willy Walker during the company’s recent conference in Sun Valley, ID.

Throughout his hour-long talk, Walker touched on multiple topics including artificial intelligence and its impact on business, the economics of climate change and the call for younger leadership in the United States. A good part of his discussion involved the Federal Reserve, rate hikes, the economy – and its impact on commercial real estate.

Rates and the Federal Reserve

Walker reminded his audience that the Effective Federal Funds Rate in July 2022 stood at 1.75%, while the 10-year Treasury interest rate was 2.64%. Fast-forwarding a year, the EFFR (as of the conference) was 5.25%. As for the 10-year Treasury, “it hit 4.22% in October,” he said. “I don’t need to tell anyone in this room that this steepness is something that we’ve really never seen before.”

Actually, not true. Walker explained that former Fed Chair Paul Volcker had boosted the EFFR from 9% to 18% between July and December 1980. Walker also pointed out that during the expansionist economy under President Bill Clinton, the EFFR was between 5% and 6.5%. But this time feels different because we’ve been in a low-interest rate environment for quite some time. “It’s important for us to realize that in this environment, it’s the transition that’s been so painful,” Walker said. “It’s getting from one place to the next that has caused so much pain in the economy.”

He also cautioned against the belief that the Fed will start cutting rates before reaching its targeted inflation rate. “They raised rates 25 basis points the week after SVB went down, even with the very real risk that there might be contagion in the banking system,” Walker noted. “If they were concerned about where they were going with rates (and) . . . the broader picture, they wouldn’t have raised rates 25 basis points.”

Office and Maturities

The real estate sector experiencing much of the pain is – probably to no one’s surprise – office. But Walker noted that office is complicated. First, out of the $4.4 trillion of outstanding commercial real estate debt, 18% of that is on office properties. Compare this to the $2.2 trillion of multifamily debt, representing half. But the concern is the $190 billion of office loans due by the end of 2023.

Still, banks like Wells Fargo and JPMorgan have come out with loan loss provisions for commercial real estate. “The regulator is allowing banks to take provisions for loan losses, then go and renegotiate these loans, and extend and pretend,” Walker explained. He pointed out that banks aren’t interested in foreclosing on office properties, especially due to the lack of any sale market. “The banking system is overcapitalized right now, very much like the Great Financial Crisis. A lot of this paper is going to get rolled.”

This is also happening in the area of CMBS financing. “Brookfield gave the keys back on three office towers in Los Angeles,” Walker commented. “The special servicers are trying to work with Brookfield on what to do with those assets rather than just foreclosing and putting them on the market.

Office and Demand

Then, there is the office sector’s bifurcation. “There are developers who are continuing to build trophy office buildings, and the trophy space is selling,” Walker said. The average per-foot trophy office space is leasing for $79, compared to $40 per square foot of Class A space. “People are paying up for trophy office,” Walker said. “Trophy office is selling because people want to be in the spot.”

Then, there is the issue of going back to work. Walker told the story of one of his bankers meeting with Cigna. Cigna pointed out that out of its 70,000 employees, 7,000 were back in the office. “After Labor Day, the other 63,000 will be back in the office or they won’t have a job with Cigna,” Walker said, adding that many companies are saying the same thing. “It’s changing, and it’s changing quickly,” he said.

Get Involved

Walker also discussed politics and the need for younger leadership to deal with issues, including artificial intelligence and its economic impact. In citing President Theodore Roosevelt’s “critic” quote, he encouraged the audience to get involved.

“There are too many people who sit on the sidelines and who throw potshots,” Walker commented. “If you care about the future of our country, get in the arena. Don’t sit on the outside and throw potshots. Understand the issues and be dedicated to them.”