Commercial Real Estate Could Bring Out More Bears

Higher interest rates aren’t just a thorn in the side of prospective residential real estate buyers and owners. Additionally, commercial real estate is feeling the pangs of a high-rate environment. That could bring out more bears in the sector.

And, the refinancing of commercial real estate could cast a cloud over the sector. Because, many properties were financed at the lower pandemic rates when real estate values were soaring.

“It’s getting worse by the week, and lots of private equity firms are admitting there’s cracks in the system,” said “Shark Tank” star and O’Shares Investments founder Kevin O’Leary. “It’s based on debt … The debt was raised for these buildings back at 3, 4 and 5%, now they’re dealing with 9 to 14% and refinancing them.”

The stability of regional banks saw testing earlier this year. That stress test could come around again in the form of commercial real estate refinancing.

“Unfortunately, what we have is many of [commercial mortgages]are on the balance sheets of regional banks, up to 40% of their balance sheets. These are going to come through, rolling through refinancings over the next 18 to 30 months,” O’Leary added. “We’re going to see more cracks on regional banks, and that’s putting pressure on the loan books of those banks which are hitting small business.”

Trade Real Estate Weakness

As rates continue to stay elevated, that should apply more downward pressure on real estate. That has been helping the Direxion Daily Real Estate Bull 3X Shares (DRN) with its 25% year-to-date gain. Stubborn and sticky inflation has been keeping monetary policy tight. While the capital markets are expecting rates to eventually come down, there’s no telling when that will come to fruition.

DRN seek daily investment results equal to 300%, or 300% of the inverse of the performance of the Real Estate Select Sector Index (IXRETR). This index includes securities of companies from real estate management, real estate development, and REITs, excluding mortgage REITs.

The higher-for-longer narrative will be a factors to watch as the Fed mulls interest rates. Applications for real estate financing saw profound impact as rates continue to climb.

“Based on the FOMC’s most recent projections, rates are expected to be higher for longer, which drove the increase in Treasury yields,” said Joel Kan, an MBA economist, referencing the Federal Open Market Committee. “Overall applications declined, as both prospective homebuyers and homeowners continue to feel the impact of these elevated rates.”

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