March 17, 2023
Read Time: 5 minutes
It’s been about a week since the collapse of Silicon Valley Bank (SVB). The dust is still settling, and many are wondering what kind of contagion effect this historic event poses.
This is one of the largest bank failures in US history… but many are saying its effect will be limited.
While the true outcome has yet to be seen, we don’t expect there to be any direct negative impact on the real estate industry.
Before I get into that… Here’s a quick autopsy on SVB.
Silicon Valley Bank failed due to mismanagement and their flawed risk mitigation.
There were 2 key actions that SVB took that led to its depositor’s panic and their eventual run on the bank.
it all starts with poor risk mitigation
By the end of 2021, SVB had a total of $189.2 billion in deposits. Yet, they struggled to find any assets to make significant returns on.
They turned to long term government bonds and mortgage-backed securities, rather than short term Treasuries, due to their higher yield.
They were also able to keep their balance sheet clean with these bonds as they were classified as “held to maturity”. So any drop in value of the bonds… due to rising rates… would only be considered a paper loss.
In fact… SVB had 75% of its debt portfolio classified this way.
6 month Treasuries were sitting at roughly .5% to .8% at the time. But, SVB saw an extra 1% in returns and went with the riskier investment.
Risk aversity requires pessimism. A good, safe investment only works, if it works in a worst case scenario.
However, human nature can blind us to this. When times are good, we like to believe that they will remain good. It’s easy to be greedy in a good economy.
And I’m sure SVB managers were thinking “Hey, even if rates increase, these bad boys are held to maturity, we’re all good.”
Fast forward a bit, and in early 2022 the Fed announced the first hike in rates since 2018, to combat inflation. The Federal Reserve would go on to raise interest rates 6 more times in 2022.
So, with rates rising fast, venture capital investing slowed… and all of these tech startups began withdrawing money. Money that SVB did not have on hand.
This is where mistake number 2 comes into play.
Paper Losses Become Reality.
In order to meet the demands, the bank sold $21 billion of its debt at a loss of $1.8 billion. But this still wasn’t enough to cover SVB and the rate at which their clients were making withdrawals.
They still needed to raise $2.5 billion. They planned to sell their stock to raise the remaining capital. But following their announcement on their bond sell off, and almost $2 billion loss… the stock crashed the next morning.
Because they sold their bonds, which were classified as “held to maturity”, that paper loss was now a reality, and sitting on their balance sheet.
Cue the panic.
On Thursday of last week, clients withdrew over $42 billion. And by Friday afternoon, Uncle Sam kicked in the door and took over.
So, what will this mean for the economy as a whole? That’s still being measured.
Being a regional bank, it’s unlikely that this will have any direct effect on real estate. But this is a unique case, due to the sheer size of the bank.
Again, this collapse is the 2nd biggest in US history.
At the very least, this serves as a reminder for investors and operators to remain risk averse, and explore options to make sure your deposits are insured under FDIC.
What Can You Do?
Your first step would be to make sure your bank is insured under FDIC… that’s easy.
Now, while FDIC only insures up to $250,000 in deposits, there are options available to you depending on the regional bank you are using.
For example, with the banks that we use, as soon as an account exceeds that FDIC limit, funds are deposited into a partnered bank account, also covered by FDIC.
And this can be done for millions and millions of dollars.
As for risk mitigation… this is another case for betting on the jockey, not the horse. You need to be comfortable with your operators, and their transparency.
If they’re only showing you the best possible outcome, and no worst case scenario, they’re either hiding it from you, or worse… they didn’t even underwrite it.
One possible indirect effect on our market would be regulations.
The response from the federal government from all of this might be to ramp up regulations on regional banks, to prevent something like this from happening in the future.
The FED is in a situation where a lot of their options are “damned if they do, and damned if they don’t”.
Sure, more regulations might make it harder to profit as much on an investment… but the risk might be lower. And vice versa.
The only possible positive news to come out of all of this, is that for the time being… It seems like ol’ Powell might be putting a pause on any future interest rate hikes.
The key takeaways here are to stay informed and make sure you’re aware of your options when it comes to FDIC.
And when it comes to mitigating risks for your deals… stay pessimistic.
If you want to hear more about how investors and operators can mitigate risks, and ensure that their deposits over $250,000 are protected by FDIC, check out this week’s episode of Multifamily Investing Made Simple.
From YouTube This Week:
AUM – The Biggest Lie Operators Will Tell You
Want To Dive Deeper:
1) Don’t Take This Investing Advice
→ Do as we say… not as we do. In this episode of Multifamily Investing Made Simple, Dan and Anthony look back at each of their respective beginnings in real estate investing, and discuss things that they did that ended up working for them… but that they would never recommend to a new investor or operator. Don’t take this advice.
2) AUM – The Biggest Lie Operators Will Tell You
→ We always hear operators stretch, twist, expand, and contort this number in every single way possible. It’s an important metric for us. It’s the total market value of our assets that we manage. But here’s the tricky part… the definition, the very formula to get your AUM, changes person by person. So one operator’s AUM may look very different than another’s, based on how they’re valuing their assets.
3) Stay Up To Date
The Multifamily Investing Made Simple Podcast is a weekly podcast where Dan and Anthony cover a wide range of topics revolving around the commercial real estate industry.
