Commercial real estate is in trouble. A banking crisis makes it worse.
If there’s one thing commercial property owners don’t need right now, it’s a banking crisis.
Large property owners around the country were already under pressure from the Federal Reserve’s aggressive campaign to raise interest rates, which increased borrowing costs and depressed building values. They also had a lot of space that was still empty in the city centers as a result of several hybrid and external working arrangements as a result of the pandemic.
Now they face the prospect that beleaguered banks, especially smaller banks, could become more aggressive with lending arrangements, giving landlords even less breathing room as they try to refinance a mountain of maturing loans. This year, roughly $270 billion in commercial mortgages held by banks will mature, according to Trepp, and $1[ads1].4 trillion over the next five years.
“There were already liquidity problems. There were fewer deals being done, Xander Snyder, First US Senior Economist for Commercial Real Estate, told Yahoo Finance in an interview. “Access to capital was becoming increasingly scarce, and this banking crisis will almost certainly exacerbate that.”
Most of the banks that make commercial real estate mortgages are small to medium-sized institutions that are feeling the most pressure during the current crisis, which began this month with the high-profile failures of regional lenders Silicon Valley Bank and Signature Bank. Pressure on regional banks continued on Friday, fueled by intensified investor pressure on German lender Deutsche Bank as the cost of insuring against default on its debt rose.
Smaller banks began increasing exposure to commercial real estate in the wake of the 2008 financial crisis, which was triggered by a housing crash, and held on even after the pandemic drained many downtown properties and other forms of lending backed by commercial mortgage-backed securities and life insurers dried up out.
Signature was among the banks that made some of those bets, becoming an aggressive lender in New York City to office towers and multifamily properties. By the end of 2022, it had accumulated nearly $36 billion in commercial real estate loans, half of which were for apartments. This portfolio accounted for nearly a third of the $110 billion in assets.
More than 80% of all commercial real estate loans are now held by banks with less than $250 billion in assets, according to a report by Goldman Sachs economists Manuel Abecasis and David Mericle. These loans now represent the highest percentage of the industry’s loan portfolios in 13 years, according to John Velis of BNY Mellon.
“There’s a lot of commercial real estate that’s been funded over the last few years,” BlackRock Global Fixed Income CIO Rick Rieder told Yahoo Finance on Wednesday. “When you raise interest rates so quickly, the interest-sensitive parts of the economy, and especially where there’s funding or leverage attached to it, that’s where you create stress. It’s not going away tomorrow.” Commercial real estate, he added, does not represent the same kind of systematic risk to the economy that housing did during the 2008 financial crisis, but there are “isolated pockets that can lead to contagion risk.”
Two early warnings about the danger that rising interest rates pose to commercial real estate came last month. Giant landlord Columbia Property Trust defaulted on $1.7 billion in floating-rate loans tied to seven buildings in New York, San Francisco, Boston and Jersey City, NJ. two 52-story towers in Los Angeles.
Foreclosures of several trophy buildings at deep discounts are expected in the coming years as owners struggle to refinance at affordable prices. “Sellers want the price that everyone got [back] in December 2021, and buyers are even afraid to buy anything right now because they don’t even know what the price of these buildings is, Synder said.
The banks were already tightening the terms on commercial property loans before this month’s chaos. According to the Federal Reserve’s latest senior loan officer opinion survey, nearly 60 percent of banks reported tightening lending standards in January for commercial and multifamily loans.
“Bank lending standards had already tightened significantly in recent quarters to levels not previously seen outside of recessions, presumably because many banks’ risk departments shared the recession fears that have been widespread in financial markets,” according to a note last week from Goldman Sachs. More tightening of lending standards expected as a result of new bank strains could slow economic growth this year, Goldman said.
Fed Chairman Jerome Powell agreed with this view at a press conference on Wednesday after the announcement of another rate hike. He said he also expects a tightening of credit conditions as banks pull back, which will help cool the economy. “We think of it as effectively doing the same things that rate hikes do,” he said.
But he said regional banks with large volumes of commercial real estate loans likely wouldn’t become the next Silicon Valley Bank.
“We are well aware of the concentrations people have in commercial real estate,” he said. “I really don’t think it compares to this. The banking system is strong. There is sound. It is resilient. It’s well capitalized.”
The larger commercial real estate world is still absorbing the shock of the Fed’s aggressive campaign, according to Marcus & Millichap CEO Hessam Nadji. The effects may not constitute a systemic risk, he added, but they will increase the industry’s many challenges.
“Commercial real estate has been through a pandemic, very rapid recovery, then massive economic tightening unlike anything we’ve seen in modern history,” he told Yahoo Finance on Thursday. “The past three years have moved the industry through a significant rollercoaster.”
Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv
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