- Approximately $929 billion in commercial real estate loans mature in 2024
- Approximately 14% of all CRE loans and 44% of office loans appear to be underwater.
- Recent research warns of widespread bank failure risks if default rates soar to 10%
Experts have warned that a sharp rise in commercial mortgage default rates could depress the U.S. commercial real estate market and trigger a new banking crisis.
Approximately $929 billion of outstanding commercial mortgages held by lenders and investors will mature in 2024, or 20% of the $4.7 trillion in total debt, according to recent data from the Mortgage Bankers Association. corresponds to
Meanwhile, rising interest rates are hurting commercial real estate (CRE) asset values across the board, with office buildings particularly hard hit by the continued popularity of remote and hybrid work.
Disturbingly, a recent research report from the National Bureau of Economic Research found that approximately 14% of all CRE loans and 44% of office loans are “underwater,” with the current property value less than the loan balance. It seems so. .
“If nothing changes, if interest rates continue to rise and property values do not improve, we see a good chance that defaults will be on par with the Great Recession, and may actually be worse.” said one of the people, Columbia Business. Tomasz Pikorski, a professor at the school, told DailyMail.com.
The study estimates that if the default rate on CRE loans were to jump to 10%, 231 U.S. banks with total assets of $1 trillion would see the market value of their assets fall below the value of their customers' deposits.
The situation could spur panicked customers to withdraw uninsured deposits in the same type of rapid run that caused the Silicon Valley bank to collapse last year.
“Due to high interest rates, dozens to hundreds of banks are on the brink of insolvency. Further distress in commercial real estate therefore leaves these banks potentially vulnerable to runs by depositors. You’re going to be put in a group,” Piskorski said in a Zoom interview this week.
He added: “This is a bonus that could actually cause problems for a significant number of banks, primarily small and medium-sized banks.”
Piskorsky and his co-authors said they believe it is “fairly likely” that commercial mortgage default rates will be 10% or higher, given the current rate of underwater loans.
Unlike a mortgage, where the principal is repaid over time, most CRE loans are interest-only. This means that you will need to repay the loan in full or refinance it when it matures.
Given that many CRE loans were issued when interest rates were low, even properties that aren't underwater can have a hard time finding a bank willing to refinance them. Some people may struggle to pay higher interest rates.
Shark Tank star Kevin O'Leary advises consumers to avoid small local banks and keep their deposits in large national banks that are “too big to fail.”
“Regional banks are doomed,” he wrote in a recent column for DailyMail.com. “Start moving money now.”
Some fear that contagion from a possible banking crisis could threaten the broader financial system.
A recent report from the Financial Regulatory Authority, created in response to the Great Recession, named the commercial real estate market as the No. 1 financial risk to the U.S. economy.
The Financial Stability Oversight Council's annual report states that “accumulating losses from CRE loan portfolios can have ripple effects through the broader financial system.”
The FSOC warned of the possibility of a “CRE devaluation spiral,” where sales of financially distressed properties flood the market, reducing the market value of neighboring properties.
Such a downward spiral could cause other commercial mortgages to fail, increase default rates, and even reduce property tax revenues for local governments.
Why are commercial real estate values falling?
Overall, U.S. commercial real estate values are down 21% from their recent peak in March 2022, when interest rates started rising, according to real estate advisory firm Greenstreet.
The steepest drop was in office values, down 35% from their peak, but the decline was across the board, from apartments and shopping malls to medical facilities and self-storage facilities.
Dylan Burzynski, an analyst and head of office research at Green Street, said the 35% drop in prices reflects trends in the highest quality “Class A” office sector, with lower-class properties falling behind. told DailyMail.com. 60 percent from pre-pandemic levels.
“The office sector is facing a number of headwinds,” Burzynski said, citing the shift to remote work, a general economic slowdown and layoffs, and tightening debt capital markets as factors weighing on office values. I mentioned it.
Four years later, remote and hybrid working is still popular among white-collar workers, who cite the convenience and significant savings in commute time and money.
As a result, the office vacancy rate has reached an all-time high. The U.S. office vacancy rate reached 19.6% last month, the highest since at least 1979, according to Moody Analytics, and the highest ever since Moody's records go back.
While real estate values in the office sector have been hit the hardest, experts say remote working could have “negative spillovers” to other commercial properties as well.
Urban retail businesses face pressure from fewer people traveling for work, multifamily housing could see reduced demand as the need to live near offices declines, and hotels face pressure from fewer people traveling for work. are under threat of declining numbers.
Piskorsky exclusively shared with DailyMail.com unpublished research showing that 12 percent of all multifamily mortgages are currently underwater.
Meanwhile, the Federal Reserve's interest rate hikes are also weighing heavily on overall commercial real estate values due to higher borrowing costs and reduced demand from potential buyers.
“Interest rates reduce the value of bank assets, but they also reduce the value of commercial buildings,” Piskorsky said.
“Many of these commercial buildings are on long-term leases. So when interest rates rise, the value of the cash flow from these buildings decreases,” he explained.
“Yes, the office is definitely the worst department, there's no doubt about that,” he added. “But even if you don't have an office loan, that doesn't mean the bank doesn't have problems.”
Why are banks at risk when commercial mortgage defaults increase?
Traditional banks hold about half of the $929 billion in commercial mortgages maturing this year. That total is up 28% from the $728 billion that matures in 2023, according to MBA data.
According to NBER research, CRE loans account for about a quarter of the average bank's assets, accounting for about $2.7 trillion in total bank assets.
The study found that if CRE loan default rates had jumped to 10% in early 2022, when interest rates were still low, any U.S. bank would have been able to absorb the shock without risking failure. .
But as the Fed's benchmark interest rate rose to 5.33% from near zero two years ago, the total market value of assets held by U.S. banks fell by about $2 trillion, the study found.
The authors argue that many banks are not properly adjusting their portfolios to manage risk, and warn that hundreds of lenders will face bankruptcy if default rates on CRE loans jump to 10%. There is.
Those banks could face failure if customers with deposits exceeding the FDIC's $250,000 insurance limit seek to move their uninsured deposits.
“What we have shown in our research is that hundreds of banks could potentially fail if uninsured depositors withdraw their deposits,” Piskorsky said.
“Even when it doesn’t, there is a good balance in place. For that good balance to occur, uninsured depositors need to have confidence in the banking system, which is what regulators are trying to instill.” “There are,” he added.
While it is by no means guaranteed that default rates will rise above 10%, given the high proportion of commercial mortgages that have already failed, Piskorski and his co-authors say it is entirely possible. thinking.
The commercial mortgage delinquency rate, a leading indicator of default, was 3.2% in December, up from 2.7% in the previous quarter, according to the MBA.
If defaults spike, the banks most at risk of failure will be small regional financial institutions with a high proportion of CRE loans on their balance sheets.
Large banks such as JPMorgan, Bank of America and Citigroup are not at risk because commercial mortgages make up a small portion of their balance sheets.
According to research by Apollo, small banks account for nearly 70% of all CRE loans outstanding.
Among smaller banks with large CRE loan portfolios, lenders with a large proportion of uninsured deposits may be most vulnerable to a run.
New York Community Bancorp's recent troubles come after the financial institution posted an unexpected loss in the fourth quarter on loans related to the stressed commercial real estate sector. It sounded the alarm.
NYCB's market value has fallen by nearly $4 billion, or about 50%, since Jan. 31, when it reported increasing its provisions for bad debts and cutting its dividend.
Still, some observers expect the banking system to be able to weather the rise in CRE loan defaults without widespread failure.
Analysts at Morningstar DBRS expect the CRE woes to weigh on U.S. banks' financial performance, a process that will span multiple years and result in losses as lenders grapple with maturing loans. is expected to expand.
“Some of these loans are in good standing and will be refinanced, some will be extended and some will become distressed,” the rating agency said in a recent note.
