Few industries have been as affected by the COVID pandemic and its aftermath as commercial real estate.
Inflation, rising interest rates and the continuation of work-from-home arrangements have plagued the sector, and U.S. financial regulators are keeping a close eye on the sector as commercial real estate loans are widely held by banks, insurance companies and other financial institutions. institutions.
The Financial Stability Oversight Council released its 2023 annual report Thursday, naming commercial real estate first in its list of financial risks to the U.S. economy.
FSOC was formed in the aftermath of the 2008 financial crisis to identify potential risks to the financial stability of the United States and promote market discipline. It consists of the heads of the top US financial regulators and is chaired by Treasury Secretary Janet Yellen.
The report noted that commercial real estate loans totaled nearly $6 trillion in the second quarter of 2023, about half of which was held by U.S. banks, and that “a substantial volume” of these loans will mature in the coming years.
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Regulators are concerned that a vicious cycle could emerge, where high office vacancy rates leave borrowers unable to finance their debts, which in turn leads to distressed sales that impact the value of neighboring properties. The lack of traffic in some business districts also has the cumulative effect of reducing demand for restaurants and retail locations in business districts.
Given that commercial real estate loans are the largest lending category for nearly half of U.S. banks, and that a quarter have commercial real estate loan portfolios that are large relative to their capital reserves, banking watchdogs also fear that problems in the sector could lead banks to lend less to all sectors of the economy.
“Connections between financial intermediaries operating in the commercial real estate market, including banks, insurance companies, REITs and private lenders, could increase financial stress in the sector,” the report said.
Vacancy rates in large multifamily apartment complexes are also now rising and property values in that sector are down 4% from pre-pandemic levels and 16% from the year before, the report said.
More pain will come in this sector, too, especially in the “American sunbelt markets” of Texas, Florida and Arizona, where new properties are being built at a rapid pace even as rents have slowed to rising or even falling.
A financial stability report issued by the Federal Reserve in May also cited commercial real estate as a significant risk to the economy and banking system, and research released last month by the St. Louis Fed showed that debt levels in the sector increases as prices fall and Few deals have been restructured.
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The study found that smaller banks tend to have greater exposure to commercial real estate debt, which could indicate that the struggle in the regional banking sector KRE,
as became clear earlier this year after the collapse of Silicon Valley Bank and Signature Bank of New York, could continue.
Meanwhile, following the SVB bailout, financial regulators are well aware that the problems at smaller banks could pose broader risks to financial stability.
“Risks of a possible downturn in the economy [commercial real estate sector] are concentrated among the smaller banks and not among the large bank holding companies that are widely believed to be too big to fail,” the St. Louis Fed researchers wrote.
“Yet, as the 2007-2008 financial crisis showed,” they added, “large waves of failures at even small institutions can cause significant disruptions in financial markets and later spread to the real economy.”