The Extend And Pretend Era Comes To The End
One unofficial program that lived on behind the scenes was the extend and pretend plan for commercial real estate, where banks and other lenders do not want to take the unrealized losses from their real estate portfolio. One of the fallouts from Covid was the sudden acceleration of office space devaluations. Office buildings were already having some degree of struggle before the pandemic as high-speed internet and work from home had already begun showing up prior to 2020. But once Covid sent millions of workers home and we collectively learned that a lot of work could be done remotely, it created a huge problem for the investors in commercial real estate.
While multi-family (apartments) and retail commercial properties have also had trouble, it's the commercial office space in downtown areas and in the suburbs that has the biggest losses. Many of these buildings have few tenants and they are upside down in terms of making money. The majority of office buildings are now money losers, which means there is little to no incentive to either maintain or make improvements to those buildings, which in turn sets a downward spiral for the buildings. Who wants to setup in a building that looks old, worn and has a low level of maintenance? We've all been in an old office, old medical building, you can just tell by the look and smell of the place. When a company is looking to rent new office space, they will most likely walk away from these slowly decaying offices.
The values of these office buildings has fallen but the owners haven't sold. In many instances they cannot sell, as the outstanding debt for the building is larger than the (now lower) price of the building. Both parties (the owner and the lender) are stuck. The owner does not want to take the loss on the building which will hurt their balance sheet. Now one wants to take a loss, and some of these owners are REITs or investor groups, and if they report back to their investors that they took a huge loss when they sold it could scare away future investment. The lenders don't want to take the loss either, once they book that loss it will decrease the assets they have on the books, which can in turn bring pressure from the executives and shareholders at that bank.
Rather than confront all these embarrassments and difficulties, everyone in commercial real estate decided to just pretend the disaster wasn't happening. Thus we got the extend and pretend, where the lenders will just extend the terms of the loan and both sides pretend that the unrealized losses do not exist. This got underway in a big way in 2022 and continued on into 2023, 2024. By 2025 the extend and pretend became more like pray and delay, where everyone was hoping that lower interest rates and a return to work initiative from many corporations would bring about some price increases for those buildings. But that largely has not come to pass.
What has happened as we close out 2026 is the decision by many lenders to stop extending and stop delaying, but instead to begin booking the declines and taking the losses.
Now the question is just how much less are all these buildings worth in reality versus what is written on the loans? The best estimates are that commercial real estate in the United States is about $2,5 trillion to $3 trillion in losses. This is a massive problem for lenders, particularly to certain US banks, some foreign banks, and the private credit industry. While the losses have been slowly realized, some properties have been sold off, many more buildings are waiting for their turn in the liquidation process and as we move through this great unwinding there will certainly be more losses, and more dangerous losses for these huge lenders.