SVB Collapsed - Its Impact on Commercial Real Estate

David Cohn
Apr 20, 2023
Current Trends

The recent news about Silicon Valley Bank (SVB) going out of business has caused a stir in financial circles, with concerns that it could have repercussions for other institutions and ultimately impact the commercial real estate (CRE) market.

SVB was a California-based financial services provider catering to technology and life science companies, entrepreneurs, and investors. Its prestigious clientele included industry giants like Apple, Google, and Amazon, known for their innovative and fast-paced growth.

Given the potential implications of SVB's closure, it is crucial to thoroughly investigate the details and analyze the situation.

How did SVB fail?

The failure of SVB is considered one of the biggest bank failures in US history. Simply put, the bank was forced to shut down due to an unexpected surge in deposit outflows.

According to its latest financial filing with the Securities and Exchange Commission, it had approximately $2.6 billion in CRE loans, with 35% of these loans backed by multi-family properties and offices (around 21%).

In addition, SVB had $8.3 billion in personal residence mortgage loans and around $138 million in home equity credit line loans.

Furthermore, SVB had an investment securities portfolio that included $1.3 billion in qualified, affordable housing projects, $14.4 billion in commercial mortgage-backed securities issued by agencies, and $2.7 billion in equity securities that were non-marketable or other.

Notably, Signature Bank, which also collapsed after SVB, focused on providing commercial multifamily loans for nine different industries, and almost half of these loans ($36 billion) were secured by commercial real estate.

In late 2021, SVB acquired Boston Private, a wealth management, trust, and banking services provider with substantial real estate investments, for $900 million.

This acquisition was part of SVB's larger strategy to focus on innovation sectors such as technology, life sciences, healthcare, and venture capital.

Does SVB’s collapse affect the commercial real estate market?

The collapse of SVB has the potential to impact more than just the technology industry and the economy. It could also affect other sectors, including commercial real estate investments.

CRE investments are a common way for investors to diversify their portfolios and generate income, encompassing a variety of commercial properties such as office buildings, retail spaces, warehouses, and multifamily apartments. Examining how the SVB's failure may affect these types of assets and the CRE landscape is crucial.

  • CRE financing - SVB was vital in providing loans to technology companies and real estate developers. With their lending, a supply of credit could be available in the market. This credit squeeze can make it more challenging for investors to obtain project funding, leading to a decline in new commercial real estate developments and a slowdown in some segments. Although SVB's primary focus was lending to venture capital and private equity firms, approximately 15% of their loans were directed toward residential mortgages and commercial real estate. These loans will have to be transferred to other lenders.
  • Interest rates - To prevent the risk of contagion, the Fed may adopt a significant policy shift, such as halting or reducing mortgage interest rates. However, the Fed may have to resume rate hikes once the short-term liquidity risk has passed. If the Fed were to lower short-term interest rates, it would be a considerable boon to the real estate market, including property development. Furthermore, this could prompt more institutional investors to search for better opportunities in real estate, causing cap rates to fall.
  • Multifamily housing - Despite the collapse of SVB, the multifamily sector is likely to remain resilient as people will still need accommodation, and some potential buyers may opt to rent instead. The multifamily industry could benefit from the situation. Additionally, the number of retirees, a significant factor driving demand for multifamily properties, is expected to continue increasing. Therefore, the multifamily sector may grow despite the SVB's collapse.
  • Office CRE - The closure of SVB may negatively impact the technology industry. After all, many of the bank's clients could need help obtaining financing and capital, leading to decreased demand for commercial real estate. This could result in companies reducing their operations and downsizing their office space requirements.
  • Retail and hospitality CRE - SVB's collapse in the retail and hospitality sector could cause a wider economic recession, resulting in decreased consumer spending and reduced demand for retail and hospitality properties. As a result, vacancies may rise, and rents may fall, causing a drop in the value of CRE investments.

If the events surrounding SVB accelerate the onset of a recession, more properties will likely default sooner rather than later. This could pose a significant problem for lenders as they have increased their real estate financing.

The Federal Reserve reports that total real estate loans and leases on lenders' books have risen by 16 percent since mid-2021, reaching a record $5.31 trillion.

Last year saw an 11.2 percent increase in real estate loans, the highest since 2006 and equal to the previous four years combined. Another cause for concern is that Commercial Real Estate loans make up around 24 percent of all bank loans—the highest since the financial crisis.

The National Council of Real Estate Fiduciaries' index has shown that CRE property values have decreased, with prices falling 3.5 percent in the last quarter. This drop is the largest since 2009 and only the second time there has been a quarterly decline.

One of the main reasons for the price drop was the office property sector. Some banks have started taking specific steps to minimize their risk. For instance, M&T Bank has reduced its exposure to projects under construction.

However, the bank also stated that assisted living facilities and offices could become problematic while the hotel sector has improved. Lenders have likewise tightened their standards for providing credit for CRE.

For example, the Federal Reserve's most recent quarterly survey of loan officers indicated that 57.6% of participants reported increased lending standards.

There is a concern that the current situation in commercial real estate could lead to a crisis in the banking industry similar to the savings and loan crisis of the late 1980s and early 1990s. This crisis was caused by many property loans and investments turning bad, resulting in a recession.

It's still too early to know if this will happen again, but history has shown that a healthy banking system is essential for a healthy economy.

Moreover, according to some industry experts, the issues at SVB indicate that there may be weaknesses in the banking system that we were previously unaware of.

Should CRE investors be worried?

A major economic event like SVB’s failure can affect different facets of the broader economy and commercial real estate investments. The collapse of SVB and Signature Bank and the resulting decrease in lending liquidity may lead to tighter financial conditions.

This could compound existing challenges in the commercial real estate industry, such as rising interest rates and lower valuations, and further restrict access to credit. Underwriting standards are also expected to tighten and add to the turmoil.

The Federal Reserve's plan for interest rate hikes to combat inflation will be closely watched to see how it may impact the situation.

Despite potential limitations to liquidity, specific CRE segments—particularly the multifamily sector—will likely continue to generate lucrative investment returns for passive investors due to a persistent, robust demand and a shortage in relative supply.

Furthermore, industry experts anticipate that the Federal Reserve will try to prevent contagion and associated consequences, and the current crisis will eventually subside. Many experts believe that the commercial real estate sector is in an excellent position to withstand a possible recession.

According to Deloitte's 2023 Commercial Real Estate Outlook, 66% of respondents believe property revenues will rise in 2023 due to the industry's strong fundamentals. This belief is not unfounded. Several positive indicators within the sector include low vacancy rates, intense leasing activity, increasing rents, and a thriving transaction market.

These favorable factors will continue to attract investment and lead to healthy returns even if the economy experiences a downturn.

As CRE investors navigate the economic downturn, they can protect their balance sheet by maintaining reasonable liquidity and reducing current debt to at least 50% or 30%. In addition, some analysts suggest refinancing any maturing debt with balloon payments within five years.

In addition, CRE businesses can leverage workflow optimization software and AR management tools to monitor financials better.

Leveraging big data analysis solutions that offer insight into changing market trends could be beneficial. Intelligent platforms with predictive analytics are vital for professionals to stay ahead of the competition.

These software solutions use artificial intelligence to recognize potential budget overruns and provide strategic insights that lead to more predictable outcomes.

With advanced technology in their corner, CRE firms can remain competitive regardless of market conditions.

While there may be some turbulence on the horizon, commercial real estate players who understand market dynamics, possess prudent risk management capabilities, and are equipped to adapt to changing cycles will do just fine.