The Biggest Fight In Real Estate Is Playing Out Behind The Scenes As An Ultra-High-Stakes Poker Game

Have you ever seen a poker game where both players are bluffing each other at the same time even though one of them has a lot more to lose than the other? That scene is similar to the state of affairs between mortgage lenders and investors.

Commercial Real Estate Debt Is A Multitrillion-Dollar High-Stakes Poker Game

The proverbial "pot" in this high-stakes game is control over the hundreds of billions of dollars in toxic commercial real estate assets, and the outcome will have dramatic repercussions on real estate investors and everyday people around the world. The Wall Street Journal estimates over $2 trillion worth of commercial real estate loans will mature between now and 2027.

Office property in America's biggest cities represents a significant portion of that debt, and if they continue to languish at or near all-time highs in terms of vacancy rates, the loans secured by those properties aren't going anywhere but bad. That reality is pitting two groups of investors, neither accustomed to losing, against each other.

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The mortgage lenders and debt funds, which made aggressive bets lending heavily on commercial real estate after the great financial crash of 2008, are on one side of the table. They want their money back. On the other side sits the investment funds and distressed asset hawks that buy real estate at rock-bottom prices and then profit off the upswing as they try to make a ton of money.

Both The Bankers And The Buyers Are Bluffing 

The banks and their borrowers are both bluffing because they are aware that the massive loan balances can't be paid back. A few years remain between now and when the notes come due so the banks (and their borrowers) have time to hope for a turnaround in the office market.

In the meantime, investors and distressed asset hawks are offering banks pennies on the dollar to take some of the toxic assets off their hands. The banks know that selling now would result in massive losses for their shareholders, but that is not the only issue. The larger problem is that no one knows how to value the commercial assets that are getting more toxic by the day.

Valuing Toxic Office Assets Is Challenging

Valuing toxic office assets is difficult because of the formula people have traditionally used to calculate the value of commercial real estate. Unlike houses, where the value is largely determined by the recent sale price of similarly sized and equipped properties, commercial real estate's valuation is contingent on how much money it's generating. With office real estate facing an average vacancy rate in the 20% range, it can't possibly make money.

Complicating matters is that banks lend money based on an office building's valuation. If the owner of a "hot" property in the middle of downtown New York or Los Angeles that was flying high in 2008 borrowed money based on that 2008 valuation and the asset is now only 80% occupied, what is that property worth today? It's not as valuable as it was in 2008.

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This is where the distressed asset hawks come in and make low offers, but lenders are (so far) unwilling to take the kind of losses and write-downs on the loan balances that would go hand in hand with accepting the low offers. That is slowly beginning to change, which makes sense considering that by some estimates, banks are holding about 40% of the several trillion dollars in America's outstanding commercial real estate debt.

When Will The Bluffing Stop And The Deals Start Getting Made?

Scott Rechler, CEO of real estate investing firm RXR told Axios, “We are starting to see some movement — not a lot yet — in deals where lenders are willing to start trading at prices that better reflect the substantial discounts that you need, to attract capital to invest in office.” 

However, valuations remain a sticking point, with Rechler noting, “We’ve seen multiple appraisals for the same building be 25% off of each other.”

This has led to a standoff between bankers and would-be distressed asset buyers, who are casting wary eyes at each other across the poker table, with neither side showing any willingness to back down. As the saying goes, money changes everything. Real estate data firm Trepp estimates that $265 billion in office loans are coming due in 2024 and 2025.

Rechler said he thinks that will lead to movement in the market and a meeting of the minds on valuation. 

“Once investors and lenders have better visibility of where values ultimately land and what structures are being used, I think you’ll start seeing an uptick in trades,” Rechler said. “It’s going to be a process through this year and into ’25.”

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