(Anybody in the US government want to buy more toxic assets from banks?)

The title of the post is an old investment adage that has proven true time and again over the centuries.

What it means is that when you think a market is swirling down the toilet and you sell, you really need to sell everything, even if it means taking a loss, because if you hang on to even some of the investment your next losses will be bigger.

The trick is to know the difference between a declining market that may have upsides, and a market where all the indicators are rapidly blinking red on the downside; a market where there is no indicator of an upside or recovery but only those pointing to a decline – in which case it’s likely to be a rapid decline, meaning collapse, implosion, ..(checks thesaurus).

And so it is today with two of the biggest markets for Commercial Real Estate (CRE) in the world: the USA and China

Two years ago my fellow blogger, NickK, had a post on the Chinese property development company Evergrande and its troubles with bond payments, Evergrande survives…..for now, where he raised the prospect of it being “too big to fail”.

Well it wasn’t. Last Thursday Evergrande finally filed for bankruptcy in New York, using lesser known part of US bankruptcy law, Chapter 15, instead of the better known Chapter 11. The former is when another country is involved.

There has been a string of such bankruptcies that have been building over the last few years (this from late 2021):

But Evergrande was the largest. Is it any surprise that the following analysis goes directly from China’s slowly-and-then-quickly moving property crisis to it’s Dead Man Walking economy, which points out a lessor light of failure (lessor only because not as well known in bankruptcy discussions over the last few years) – Country Garden ($US 80 billion sales in 2011 and last monthly report for July was down 50%).

Understand that both of these companies have tens of thousands of unfinished apartments and houses for which Chinese citizens have already paid up front, which is the Chinese model. So in order to prevent riots the CCP will have to bail out these companies just enough to finish these buildings – but nothing more. So a $200 billion loss for Country Garden and $80 billion loss for Evergrande (the latter only smaller because it had already devalued in recent years). There are others and then there’s all those Chinese banks who lent them money?

But if you’re living anywhere else, don’t get too cocky, especially if you’re in the USA:

Cerberus Capital Management and Highgate missed two months of payments on a $415 million loan for 30 Courtyard by Marriott hotels, another sign of spreading trouble in commercial real estate. Cerberus and Highgate have requested an extension of the floating-rate loan, which matured in July, according to a servicer report.

“Borrower stated that they do not have enough funds to cover the shortage and the regular monthly debt service,” according to the report.

Okay you may say, in any industry there are going to be companies with problems like this, and who go bankrupt. But it’s the reasons here that matter, because they’re across the entire commercial property industry and they arise from the combination of Chinese Lung Rot policies of work-from-home, plus crime and homelessness issues that have emptied CBD’s across the USA, to rapidly rising interest rates due to all the insane government spending to compensate for the insane lockdown policies.

Now combine that with typical CRE structures:

  • CRE properties are office buildings, shopping centers, hotels, apartments, etc. that produce income from rent paid by tenants.
  • The owners typically finance these properties for terms of 5 to 10 years (but on a 20 or 25-year payout) with a balloon payment that is due at loan maturity.
  • The amount borrowed for the loan must obviously be less than the value of the property.
  • Rent income must be able to support the debt.

Renewing loans right now means a doubling of interest rates, which means increasing rents to cover it. Except all the office vacancy pressures are to push rents down.

In which case an investor may just sell the damned thing. Except that is now becoming a problem (The SF one I’ve covered before):

Not just any two hotels in SF but the 1,921-room Hilton San Francisco Union Square and the 1,024-room Parc 55 San Francisco. These supposedly elite properties were not enough to stop the owners from just walking away from (defaulting) on a $725 million CRE loan.

And when that starts happening guess who also wants to sell something – the banks and their CRE’s:

Lenders including Goldman Sachs Group Inc. and JPMorgan Chase & Co. have been trying to sell debt backed by offices, hotels and even apartments in recent months, but many are finding that tidying up loan books is no easy feat when concerns about commercial real estate have surged.

Banks seeking to sell commercial-property loans are encountering a dried-up market with few options for an easy exit.

“Even if most of these are performing loans today, they’re trying to reduce their exposure by selling loans at a discount as they head into a refinance cycle,” Hagood said. “A lot of these banks will say, ‘I’d rather take the hit there than take the hit on a foreclosure and have to deal with the asset after.’”

Goldman and JPMorgan, along with other banks including Capital One Financial Corp. and M&T Bank Corp., have sought to sell property debt in recent months, seeking buyers both for one-off sales and transactions for portfolios of loans, according to people familiar with the matter, who asked not to be identified citing private information.

As the old adage has it: a known, manageable loss right now makes perfect sense if it gets a loser CRE loan off your books.

But who would want to buy a ticking time bomb at any price?

Ladies and Gentlemen, I give you the United States Federal Government. Just ignore the $33 trillion debt it already has.