Real estate is the crisis risk to watch out for

As you will doubtless have been informed, world equities are now in a bear market. What happens next?
The most excessive speculation has already been washed out of the system. Those warning of bubbles in bitcoin and other cryptocurrencies, meme stocks, or the growth tech companies owned by the ARK Innovation ETF certainly seem to have had a point. By last November, meme stocks were so exciting that their own benchmark gauge, the Solactive Roundhill Meme Stock index, was initiated. Since then, that index has dropped 70%. The same is true of ARK and bitcoin — this looks like a wave of speculative excitement that flowed into the same things together, and has now flowed out again.
These investments still matter, and it’s possible that they have further to fall. In the case of bitcoin and the crypto sector, it’s also possible that they are big enough for losses to create systemic effects, as their falls force sales of other assets. But they are not central to the questions that confront us now.
What we need to know is whether further accidents lie in the future. And that to a large extent depends on leverage. When unleveraged investments fall, the people holding them lose some of their wealth. That probably has some effect on spending in the economy, but broadly speaking that’s that. Relatively well-off people who hold investment assets are now relatively less well-off.
When leveraged investments fall, companies and their lenders can go bust. The need to pay off the debt can prompt fire sales elsewhere. So, we have our higher rates, and the financial system is now discounting significantly increased borrowing costs into the future. This should bring inflation down — but the risk is that it will create crises for leveraged investments that cause further damage. So, the question, as ever when weighing the risk of a financial crisis, and doing some violence to the French language, is: “Cherchez le leverage.”
If there is one asset that should come under scrutiny, it is real estate, whose life blood is credit. For a double whammy of higher rates and
the lasting effects of the pandemic, look to office property. Remarkably, Bloomberg’s index of US office property real estate investment trusts, or REITs, is slightly lower now than it was 20 years ago, and almost back to the lows it hit during the worst of the pandemic in 2020.
For anyone who has beheld the growth of the Manhattan skyline in recent years, barely even slowed by Covid-19, this is alarming. The travails of Vornado Realty Trust, one of the biggest developers in New York, whose share price is 59.5% below its high from five years ago, suggest the scale of the issue; the fact that a number of developers only narrowly fended off industrial action by building staff earlier this year also indicates the pressure.

—Bloomberg