Bank Turmoil Fuels Short Sellers' Bets Against Office Owners

Money managers have increased their wagers on office landlords, betting that the regional banking crisis in the US will make it harder for property owners to obtain credit at a time when they are already struggling due to the epidemic and rising interest rates.

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To wager against the corporations and their debt, hedge funds use equities and credit derivatives. Data from analytics company S3 Partners show that around 40% of the shares inside the iShares US Real Estate ETF are short sold, which is the biggest percentage since June.

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According to information gathered by IHS Markit Ltd., short interest at Hudson Pacific Properties Inc. peaked earlier this week at a record 7.4% before falling to roughly 5% of shares outstanding. That is almost twice as high as it was a month ago. Short interest for Vornado Realty LP

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There are concerns about the potential effects on commercial real estate credit after the failure of three regional banks in the US. A lot of lenders are loosing deposits, which may limit their future capacity to finance real estate. The majority of bank loans for commercial real estate are made by regional banks, according to Goldman Sachs Group Inc. economists.

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Rich Hill, chief of real estate research methodology at Cohen & Steers Capital Management Inc., said that the credit markets have changed in recent weeks. "It went from the a story of telecommuting and its effect on tenancy and the lack of rent expansion to also the cumulative of tighter economic circumstances given everything happening with banks," he added.

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According to a report released on Tuesday by Green Street analysts, concerns over tighter financing are raising already existing risks for workplaces. The founder of Polpo Capital Management, Daniel McNamara, and hedge fund manager Jim Chanos are among the people who have been wagering for months than landlords will find it difficult to entice employees back to their places of employment.

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The regional banking problem, according to McNamara, "is only adding fuel to the flames." "I simply don't see a path to overcome this significant suffering in the office sector," the author said.

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Victimized Landlords

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According to a report released on March 17 by S&P Global Inc., the real estate sector is now the most shorted among all global equities. The third-most-shorted sector in the economy was

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This is partly due to the pressure real estate owners are under from rising interest rates over the past year. As of now, there are few defaults. But according to MSCI Real Assets, office assets represent the security for around $100 billion of the $400 billion in US commercial real estate debt expiring this year. According to MSCI, workplaces valued up to $40 billion are more likely to experience hardship than residences, hotels, shopping centers, or any other sort of commercial real estate.

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Due to investors' declining interest in purchasing commercial mortgage bonds, access to credit for commercial real estate has already been difficult this year, according to analysts at JPMorgan Chase & Co. including Chong Sin. According to statistics gathered by Trade Algo, sales of CMBS deals without state support have decreased by more than 80% this year.

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According to the JPMorgan analysts, the potential retreat of smaller banks could result in a credit shortage in smaller markets.

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According to data source Trepp, lenders provided a record $862 billion in commercial real estate loans last year, a 15% rise from the year before. Banks were a major factor in that, as they created 50% more loans during that time. Data from the Federal Reserve reveal that since then, growth has slowed as the real estate outlook has become more bleak.

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Because of the strain on offices, lending criteria are increasingly being tightened, which is problematic for landlords who have significant levels of leverage and increases the chance of default for lenders.

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According to a note published on Monday by Morgan Stanley researchers including Ronald Kamdem, "recent developments have heightened negative risk to commercial real estate values from concerns of tightened lending criteria." They claimed that in order to properly refinance, office REITs could need to liquidate assets.

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Last year, when rising interest rates put pressure on the sector, shorts rose on office landlords. Then, they fell as a result of bets made by investors that borrowing standards would peak at a lower level than anticipated or that the Federal Reserve would start lowering interest rates sooner than anticipated.

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As the epidemic caused offices to lose value, Cohen & Steers, which is in charge of managing nearly $80 billion in real estate holdings, will stay away from them until the market begins to show indications of bottoming out.

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Hill remarked, "I genuinely desire further shows of vulnerability. "The more dire headlines I read, the closer I believe we are to the end," the person said.

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In January, Chanos said that he had been gambling on SL Green Realty Corp., a stock in which recent short interest had reached its highest level since the financial crisis. A New York building used by Credit Suisse Group AG, the bank taken over by UBS Group AG after negotiations facilitated by the government, is among the landlord's holdings. Borrowing stock, short sellers sell it with the intention of later purchasing it at a cheaper price, making a profit.

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Chairman and CEO Marc Holliday stated at the Citigroup Inc. conference that the landlord intends to sell $2 billion worth of real estate, reduce its debt by $2.5 billion, and restructure a $500 million mortgage. The corporation is dependent on banks, which was already difficult because the subprime market and life insurance funding weren't open to agreements.

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Banks are currently more likely to refuse than to carry out, according to Holliday. Knock on wood, perhaps we'll be able to accomplish that.

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In a statement sent through email, Hudson Pacific's president, Mark Lammas, expressed the company's confidence in both its long-term prospects and business fundamentals. According to Lammas, the company has an investment-grade rating, most of its assets are free of debt, it has $1 billion in cash on hand, and its next significant debt maturity isn't until 2025.

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Requests for comment from Chanos and the Vornado and Boston Properties reps were not immediately fulfilled.

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A widowmaker

Hedge funds have also been betting on CMBS that are most vulnerable to offices using credit-default swaps indices known as CMBX. The derivatives, which are linked to a fraction of bonds secured by commercial mortgages, hit record lows this week as a result of worries about several regional banks.

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Because losses might take time to materialize and even distressed properties can have a wide range of outcomes, betting against commercial property has historically been a challenging strategy to make money. According to Morgan Stanley trader Kamil Sadik, "shorting CMBX BBB- is known as the widowmaker – the destruction of many a young trader's career."  

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The BBB- component of the 14th CMBX index, however, is at its lowest level ever due to the recent spate of negative news, and the same portion of the 13th index is at its lowest level due to the pandemic in 2020. Share prices of commercial landlords are also experiencing similar drops.

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While the equities have continued to underperform, "our dialogue with investors implies that there has been some surrender and forced selling," noted Morgan Stanley analysts lead by Kamdem.