Should we fear a US banking contagion?

EDITOR’S COMMENT Contagion. It’s the name of a now eerily realistic thriller starring Matt Damon, Jude Law and Gwyneth Paltrow, but also a word I am hearing trip off the tongues of investors more and more. The first quarter of 2023 did not end well for the US, with three mid-size banks shut down and sold by US regulators as customers started withdrawing money en masse. And it wasn’t just the US; Swiss bank Credit Suisse also succumbed, being rapidly rescued by rival UBS. With the UK traditionally following in the footsteps of the US, it is understandable that fears are growing that what is happening on the other side of the Atlantic could happen here. But could it really? The US’s regional banks – those mid-size firms that have collapsed – have a sizeable exposure to commercial real estate, although largely in the sub-$50m (£40m) bracket. UK banks, while still exposed, seemingly learnt their lesson from the global financial crisis and are nowhere near as invested as they were pre-2008. Lloyds, for example, which reported its Q1 figures this week, has some £11bn in direct real estate, with only 14% of that secured against office assets, 10% against retail and 11% in industrial. The vast majority (51%) is in residential. And gone too are the days of ridiculously high LTVs. On average, said Lloyds, its portfolio had an LTV of just 44%. And while valuations have tumbled, they will have a long way to go for most assets to be deemed underwater. So there’s one reason to be hopeful that contagion does not spread. Another is to look at our real estate market. In the US, office vacancy rates in the first quarter of 2023 stood at 18.6% – some 5.9 percentage points higher than the final quarter of 2019, pre that other contagion. In the UK, office vacancy rates in Q1 stood at 6.9%, according to figures from Cluttons. A marked difference. In the UK, we as individuals are headed back to our offices more regularly than our American cousins too. Figures from JLL last month revealed that US office occupancy was 40-60% of pre-pandemic levels, while in Europe figures are now 70-90% of pre-Covid levels. And here’s the big one. We also have a lot less office space. Because us Brits aren’t quite so brash and ballsy, we tend not to over deliver (perhaps we under deliver sometimes, but that’s a whole other piece). While vacancy levels in the US have risen, so too have office development pipelines. Supply of new space stood at 4.5m sq ft in Q1 2023, one-fifth more than in Q4 2019. Here in the UK, supply has been falling. Savills data shows 8.5m sq ft of supply under construction in London this year, falling to 3.3m sq ft, 2.6m sq ft and 2.1m sq ft over the following three years, with 43% of planned office development not yet started. A bit of British caution. We are also, at least for the time being, ahead of the US when it comes to improving the environmental standards of our building stock. We are getting much better at creating offices that people want to be in. So technically we shouldn’t see contagion here in the UK, but only a fool doesn’t prepare. And while the fundamentals of our banking system and real estate market are much better placed to withstand the storm we are currently battling, it is sentiment we should fear. Transactions are slowing – just ask any of the big agencies. Capital is out there but it is thinking long and hard about where to put its money. And with real estate and investment being so global, what is happening in the US will impact decisions elsewhere. And when the Oracle of Omaha’s right-hand man Charlie Munger warns on “a lot of agony out there”, you stop and listen. Warren Buffet himself says it best, of course: “Risk comes from not knowing what you’re doing.” Good job you’ve got us then, right? To send feedback, e-mail samantha.mcclary@eg.co.uk or tweet @samanthamcclary or @EGPropertyNews