Why commercial real estate will be central to the next credit bust

On Sunday, macro strategist Lawrence McDonald made three tweets about US corporate real estate I think merit highlighting. They show a corporate real estate market that has been white hot during this particular US business cycle. And that means it is one of the credit sectors to watch for signs of distress.

Here’s what he tweeted (newsletter readers hit the date link below because it displays all three tweets):

U.S. Commercial Real Estate Loans as a % of GDP

Today: 7.0%
2000s: 6.1%*
1990s: 4.4%
1980s: 5.5%
1970s: 3.7%

*2007 high of 7.3%

FRED

— Lawrence McDonald (@Convertbond) June 11, 2017

U.S. Apartment Units in Construction

2017: 740k
2015: 540k
2013: 330k
2011: 210k
2009: 180k
2007: 410k

FOMC, DOC, GS data#CMBS

— Lawrence McDonald (@Convertbond)

June 11, 2017

Commercial real estate is near its pre-recession peak in terms of value as a percentage of GDP. And that level will soon be broken given the huge slug of projects now in the works.

This is an interest-sensitive business because a lot of it is done using leverage in order to multiply profits. And this makes commercial real estate vulnerable to the Fed’s present rate hike cycle.

Bottom Line: Commercial real estate is a sector that continues to do well and power the US economy forward. But there are signs of overbuilding in the absolute number of units coming online right now, particularly in residential property. This makes the commercial property market vulnerable, and we should pay attention to signs of weakness in the sector.

Update 15 June: Also see the next post on financial stability concerns at the Fed. That post is a follow to this one that is mostly about commercial real estate.