Pain Coming for 2 Sectors as High Interest Rates Cut Off ‘Lifeblood’: Howard Marks

• According to Howard Marks, tightening lending standards could seriously damage private equity and the real estate sector.
• Marks said these sectors are highly leveraged, which increases the risk of disruption.
• Experts warn, especially against commercial real estate, because the approaching debt repayment date creates risks.

According to billionaire investor Howard Marks, problems are mounting in the US credit market, and two critical points may emerge in the face of tight financial conditions.

The founder of Oaktree Capital Management expressed concern about high levels of debt in the private equity and real estate markets, two highly leveraged areas that rely on easy capital flows.

Marks said these sectors could come under increasing pressure as interest rates are likely to remain higher for longer.

“Leverage, the use of debt to boost earnings, has been the driving force behind these two asset classes,” Marks told Bloomberg this week. “But that’s where the pain is going to be in the future. And you can’t significantly increase a company’s debt service costs without affecting its earnings.”

Private equity and commercial real estate debt surged between 2009 and 2021, when interest rates remained at historic lows. Nonfinancial corporate debt and loans rose 83% from early 2009 to late 2021, while commercial real estate loans rose 46% during that period, according to the Federal Reserve.

But banks have begun tightening their lending practices over the past year. Companies are borrowing money at higher rates, which is a problem for highly leveraged industries. Total loans and leases at commercial banks rose about 2% in the 12 months ended July 26, Fed data show, compared with a 9% increase in the same period through 2021 and 2022.

The slower pace of lending is partly due to higher borrowing costs. Interest rates are at their highest since 2001, a consequence of the Fed’s fight to curb inflation.

Banks have also seen losses on their balance sheets, which has made them more stringent about lending. U.S. banks are holding about $517 billion in unrealized losses on their books, according to a May report from the Federal Deposit Insurance Corporation.

“Now, and I think in the future, leveraged companies will not be able to renew their leverage as easily, and the cost of doing so will be higher,” Marks said.

That has created “fundamental questions” in certain parts of the real estate market, such as office and retail, he added. Offices in particular have become a pain point as remote working continues and landlords cope with higher vacancies and falling property values.

According to Goldman Sachs, the entire commercial real estate sector has more than $1 trillion of debt maturing in 2024.

“When you put all of this together, we think we’re going to see some disruption that gives us and people like us an opportunity,” Marks added.

Other big investors predict companies will face greater refinancing challenges, especially since interest rates are unlikely to fall to pandemic-era levels.

Billionaire investor Barry Sternlicht recently said he predicts weekly bank closures and massive losses in the commercial real estate sector due to high interest rates impacting the sector.