As I’m writing this, I’m getting ready to attend CREFC’s 30th New York City Annual Conference and bacchanal.  Once again, we will enjoy the company of our confreres, we will network, we will get educated (yes, CREFC members do actually attend substantive sessions) and will all enjoy the curious joys of the Marriott Marquis (are you pining for the days of the Naked Cowboy?).  

We will have some fun.  We’ll all probably learn something and happily embrace the notion that the CRE finance markets are enjoying a reprieve from a multi-year doldrums we’ve just been through.  

F. Scott Fitzgerald said something along the lines of the capacity to hold two contradictory beliefs simultaneously, two opposing thoughts, in our heads at the same time and still function is the test of a first-rate mind.  CREFC is therefore stuffed with first-rate minds, because while we’re celebrating the relatively positive here and now, I’m guessing that buried in the recesses of those first-class minds is a concern that things might not actually be that great and could, at any moment, become less great.  Few will say that out loud for fear of attracting the attention of the Fates. 

Cognitive dissidence only hurts if you let it.  It’s fun, it’s easy and much less stressful to just ignore those pesky concerns.  Will we?  

There is considerable good news out there.  Green shoots abound.  SASB production is rip roaring.  Conduits are on track for the best year in many, saved in some material respects by the embrace of the five-year tenor.  The ten-year is coming in.  GDP while not wildly good, is good-ish.  The job market continues to hold up, notwithstanding some cavils about some bits inside the data set.  The June 7th report was startlingly good (noting that while bad means bad, good can mean bad, too).  Folks are continuing to come back to work, it’s not 2019, but the trend line is good.  Distressed debt is not an overwhelming reality in our market (yet).  Admittedly, stress is growing, at least as measured by the securitization market data, but still looks rather suppressed.  While CMBS loan losses are continuing to creep up, it’s more trickle than tsunami (as long as you don’t think about office sector too much).  Loan production is continuing to grow in the floating space, although it remains anemic, while short-term fixed rate borrowing is the newest “It” girl in our market.  

Received wisdom is that interest rates are indeed poised to come down…soon (or at least soonish).  Remember that the Fed’s Open Market Committee in March was still indicating three interest rate cuts this year.  While that may be off the table, several research outfits are still penciling in two 25 bps decreases in Fed funds this year.  Certainly, a majority of talking heads see at least one with continued retracement of Fed funds into next year.  And there’s plenty of dry powder.  If in fact you can find a borrower who can borrow with a 6 cap on valuation, pricing at something with a 3 handle on SOFR or Treasuries, there’s plenty of money out there.  

The warehouse business is rocking and rolling.  Someone thinks that the bridge market is going to need that liquidity soon.  They could be right.  

In other words, net/net, things are pretty good.  That makes having a party seem like a terrific idea.  Let’s celebrate for a change of pace.  Doom shame the nattering nabobs of negativism. We appear to have gotten over the generalized anxiety of a year ago that the lending business was in a long term doldrums, jobs were at risk and we’d all better figure out how to do distressed debt.  

It is therefore set up to be a happy CREFC (while there will be some panels on distress).  What must one do to fully embrace the party vibe?  It’s that first class mind thing again.  Embracing optimism while suppressing thoughts about the risks is not easy, but we’ll power through.  Alcohol, admittedly, does help.  

There remains plenty of stuff to worry about, if you’re of a mind to worry.  Let’s just agree that perhaps there’s no point in worrying about wars, pestilence, the end of days from climate change (AOC said we had 12 years to go, and I think we’ve already burned through 2.  On the bright side, if that’s true, I won’t have to refi my floating rate mortgage).  There’s no point in worrying about the Yankees tanking after the All Star break and I believe we can ignore the Zombie Apocalypse (scoping out, for this purpose, the election).  Speaking about the elections, does it matter?  Yeah, it might, but figuring out which side is going to win and then which issues therefore one must worry about is too exhausting.  

Let’s take all that off the table and not let any of that harsh our mellow.  

So, why still be twitchy?  Why can’t we simply embrace the notion that we will have a soft landing and return to sustainable growth, lower interest rates and higher valuations?  Why can’t we return to a low inflation environment with solid growth?  We can, of course.  

But, unfortunately, there’s some troubling data out there.  Ignore it if you will, but it’s still there.  Interest rates remain elevated and it’s not absolutely clear yet whether a sustained downward trend is in place.  Even if it is, as I have said in prior commentaries, I suspect the Fed chair will slow walk changes in Fed funds as inflation cools.  Even the optimists see only 50 bps of retrenchment in Fed funds this year and that’s not really enough to move the needle.  

There’s an awful lot of product out there with a coupon that 300-400 bps higher than when it was underwritten.  That represents baked-in stress that we can try to ignore, but probably shouldn’t pretend doesn’t exist.  

Back of the envelope, we have about a trillion dollars of commercial real estate debt that needs to get refi’d this year into early next.  While half of that was closed more than 5 years ago and is benefiting from significant income growth, half is at risk.  If we assume a 20-30% value degradation across market sectors, that means our market needs about $100 billion of fresh capital.  That’s for the next 12 months or so and then we’ll need to rinse and repeat in 2025 into early 2026, unless conditions become seriously more amiable.  This stressed refi wave will create enormous opportunities for some and create enormous difficulties for others,  

Remember, one man’s “rescue capital” is another’s pirate boarding party and a long future in irons at the oars.  

If your particular daydream is interest rates coming way down really fast, isn’t that most likely to happen if we have a good, old fashioned rip-roaring recession?  Is recession off the table at this point?  A plurality of the commentariat says yes, but that’s hardly a guarantee.  If demand softens and revenue starts to retreat while borrowing costs stay high and expenses remain sticky, a recession could be in the cards.  We also really don’t know what happens when all of our fiscal largesse finally burns off.  Are the good numbers for the past year really just a sugar high?  We also don’t know what the lag is between termination of fiscal or monetary excesses and the impact on the real economy.  Are we still stomping the brakes when we should be pressing the accelerator?  A recession cannot be taken off the table. 

So, let’s play Let’s Make a Deal, that delightful TV game show of yesteryear.  You want what’s behind Door #1, Door #2 or Door #3?  For our purposes, Door #1 is higher for longer in an anemic, but not recessionary economy.  Door #2 is Goldilocks – a return of low inflation, reduced coupons, higher evaluations, good income growth.  You know, like how it’s supposed to be.  Door #3 is recession.  Lower interest rates but soft valuations, suppressed income and a tough 8-20 months of slogging against a difficult macro environment.  

I don’t know (duh, what a dumb thing to say) which of the three scenarios confronting us is likely to occur, higher for longer and real distress in the CRE market, Goldilocks or recession and real distress across all the economy, including the CRE space.  What’s behind Door #1 and Door #3 (higher for longer or recession for those of you who are not keeping up) will not be fun and will require significantly different responses from market participants.  If Goldilocks is in the house, then we’ll all enjoy a much happier 2024 and I’ll stop nattering about risks.   

Under these circumstances, with rather Manichean choices between one really good outcome, and two very different but equally unpleasant alternatives, what should we do?  

That niggling thought in the back of my mind is that perfection is a rare event.  Remember when we thought we had perfection just before the dot bomb?  How about perfect in the years leading up to the GFC?  1998?  How’d that work for us?  Well, math is, as I’m sure everyone who reads this knows, is not my strong suit.  Even if the probabilities of each outcome are the same (doubtful), we still have a 2/3 chance of a not pleasant macro environment.  Pay your money and take your chances.  

If those thoughts worm their way into your head and you feel the need for a defensive crouch, what can you do?  Of course, the typical nostrums are to conserve capital, conserve cash, raise dollars for distressed debt, beef up asset management and deal with all the other unpleasantness that a downturn in demand would entail.  But if you did all that and Goldilocks showed up?  That would be very unhelpful.  You would surely lose bragging rights down at the club.  

Certainly, there is no certitude as to either of our two gloomy scenarios and the road directly in front of us continues to look pretty damn good.  Being possessed of a first class mind like all of my colleagues, I’m inclined to remain positive.  Embrace the good times.  Let’s party.  Okay, we’re partying for perfection but perfection has a chance.  Goldilocks might be in the hood!  

And probably there’s not much one can do to ameliorate the pain of an unpleasant surprise anyway.  

That’s my story and I’m sticking with it.  Here’s to a terrific second half of 2024 and a 2025 when we can put the Late Unpleasantness in the rear view mirror. 

See you at the conference.