Mar 20, 2023

What Silicon Valley Bank Collapse Means for Real Estate Investing

The collapse of the Silicon Valley Bank and Signature Bank has shocked investors. The speed at which these banks failed exemplifies a textbook case of a classic bank run—a situation where depositors pull their deposits en masse. A collapse of this proportion was last seen in 2008 when Washington Mutual collapsed and set off a destructive chain of events in the mortgage sector.

Are we set for another devastating mortgage crisis? No. Unlike the Washington Mutual incident, the collapse of the Silicon Valley Bank isn't fueled by spiking loan defaults.

A Quick Recap of the Silicon Valley Bank Collapse

Silicon Valley's clientele largely comprises startups and other technology-driven companies. These clients have been making huge withdrawals to meet their growing cash demands. The colossal cash withdrawals and the record-high inflation exposed the lender to two crushing risk factors: interest rate and liquidity risks.

A lender faces interest rate risk when these rates skyrocket quickly. Since March 2022, the Federal Reserve has aggressively raised the interest rates by 4.5 percentage points to tame soaring inflation. Consequently, the yield on the one-year Treasury notes rose by 4.75%, while the yield of the 30-year bonds rose by almost 2%.

Typically, the price of a security plunges when its yield increases. For instance, a 2% gain on a 30-year bond yield can tank its value by 32%. Silicon Valley Bank held 55% of its assets as U.S. government bonds.

As the SVB's customers made huge withdrawals to deal with their cash falls, the lender started experiencing liquidity problems. The lender sold $21 billion of its securities portfolio, incurring a $1.8 billion loss. The bank made a call to raise over $ 2 billion in new capital. The call triggered the bank run as customers rushed to withdraw their cash. The frenzied withdrawal was fueled by 88% of its deposits being uninsured. Most of the deposits exceeded the $250,000 cap set by the Federal Deposit Insurance Corp.

Significance of the Silicon Valley Bank Collapse to the Real Estate Sector

The collapse of the Silicon Valley Bank is the largest in U.S. banking history since 2008. Undoubtedly, it will trigger some changes in the real estate investment sector. But it's not all doom and gloom.

There's No Looming Mortgage Crisis

Unlike in 2008, the collapse of Silicon Valley wasn't driven by bad loans and market speculation. The bank lacked liquidity and had to sell its assets, mainly government bonds, at a loss to cater to soaring customer withdrawals. Contrary to triggering a crisis, the collapse will likely help lower mortgage rates. The U.S. government intervention is likely to result in lower mortgages in the housing sector. The Federal Reserve, U.S. Treasury, and Federal Deposit Insurance Corp. are taking quick measures to restore public confidence in the banking system. That may include halting any interest rate increases in the foreseeable future. SVB's residential mortgage-backed security holdings comprise a tiny share of the market. Forced selling of these assets is unlikely to pressure the market.

Tighter Bank Requirements

Lenders may tighten their lending requirements to further shield themselves from losses as the housing market struggles. However, strict borrowing requirements don't pose a challenge to the savvy real estate investor. Banks are likely to be more thorough when establishing a borrower's creditworthiness. That may include raising the credit score requirements, debt-to-income ratio, deposit sizes, and interest rates. However, smart, qualified investors easily meet these requirements. The only bump on their road might be paying higher interest rates, but they can take proactive measures to offset the higher payments.

Time in the Market

The adage, "it's about time in the market, not timing the market," holds in real estate investing. Research shows that long-term investors outperform those who try to time the market.

Staying on the market longer enables you to build a diverse and balanced portfolio across many sectors. Long-term investing allows you to absorb temporal shocks, such as short-term interest rate rises in strides. It enables you to focus on long-term gains and is a proven and reliable way to build wealth. It allows you to create an effective investment strategy and maximize your ROI.

Seeking professional advice when venturing into real estate investment can help minimize your risk exposure while maximizing your returns.