All capital allocators, even those who aren't directly invested in real estate (either through owning property outright or via real estate investment trusts) should have an understanding of, and view on, the real estate market. This is because almost all businesses have some sort of exposure to the property market - either because they own or rent real estate of their own or because they have counterparties who do. In a recent interview with the Real Vision podcast, Kynikos Associates founder and short seller Jim Chanos (Trades, Portfolio) explained why the commercial real estate sector might be in trouble.
Commercial debt to GDP ratios have increased significantly
Chanos has experience making money on the short side in real estate - Kynikos had profitable trades when the 2007-08 real estate bubble burst, as well as during the Savings and Loan Bank real estate bubble of the late 1980s. So it's safe to say that he understands the dynamics of this market - both for offices and retail space. Chanos believes there is an oversupply of office space, which was the case even before the pandemic:
"The amount of credit that has been extended to commercial real estate, and the amount of commercial real estate loans that are out there are really quite large...We estimate that the amount of debt in the both in the banking system and in the non-bank financials to be about $6 trillion dollars, or a little more than half of the $11 trillion of value in those subsectors. To put this into perspective, in '06 commercial real estate debt accounted for 15% of GDP. Back in '89, also the debt was about 15% of GDP - and that sunk the banking sector. Right now, the amount of commercial debt in troubled sectors is 30% of GDP."
So this buildup of debt was already quite large even before the lockdown significantly reduced occupancy rates. Office vacancy rates pre-2020 were 15%, whereas the all-time high was 19% (at the end of the 1980s). Add this to the existing overhang of retail space caused by the steady trend toward e-commerce, and you have a recipe for a potential bust. And if there's one thing that we've learned during 2020, it's that the shift toward online shopping and working from home is only likely to accelerate. For this reasons, it's easy to see why Chanos is bearish on commercial real estate.
Disclosure: The author owns no stocks mentioned.
Read more here:
- The Value Investor's Handbook: 3 More Warning Signs for Investors
- Jim Chanos on the Challenges of Short Selling
- Warren Buffett Reflects on His Mistakes
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