The turbulence in the U.S. commercial real estate sector is sending shockwaves through the banking industry, triggering concerns of a potential banking crisis. A significant portion of the debt held by banks is tied to struggling property developers, and with the recent surge in interest rates, these developers are finding it increasingly challenging to refinance their debts. As a result, banks are being compelled to bolster their reserves for loan losses, exacerbating the risks associated with the commercial property downturn.
Data from the National Bureau of Economic Research (NBER) indicates that U.S. banks held approximately $2.7 trillion in commercial and real estate loans as of Q3 of the previous year. A report prepared for the NBER reveals that about 14% of all commercial real estate loans and a staggering 44% of loans on office buildings may be in a negative equity position, where the debt surpasses the property value. This precarious situation elevates the likelihood of borrowers defaulting on their loans, intensifying the risk for banks.
Commercial property values, as reported by analytics firm Green Street, have witnessed a notable decline of -22% since Q1 of 2022, aligning with the onset of Federal Reserve interest rate hikes. Office prices have taken an even steeper plunge, dropping by -35%, fueled by diminishing demand for office space in the wake of widespread remote work adoption.
Several banks are already grappling with the repercussions of the commercial property crisis. Notable examples include New York Community Bancorp (NYCB), which experienced a more than -37% plunge, marking a 23-year low. The bank slashed its dividend and increased its provision for loan losses to $552 million, attributing the majority of the impact to exposure to commercial property loans. Similarly, Japan’s Aozora Bank reported a more than -20% decline after warning of losses tied to U.S. commercial property investments. Deutsche Bank AG quadrupled its U.S. real estate loss provisions to 123 million euros ($133 million) in Q4 compared to the previous year.
Renowned investor Barry Sternlicht has forecasted over $1 trillion in losses for office real estate, deeming it an asset class that has failed to recover from the pandemic. Sternlicht noted that regional banks, traditionally a source of funds for real estate owners, have now vanished from the market.
Reports indicate that banks are facing an estimated $560 billion in commercial real estate maturities by the end of 2025. Regional banks, more exposed to the industry, are expected to bear a more significant impact compared to larger, more capitalized banks. Commercial real estate loans account for 28.7% of assets at small banks, in contrast to just 6.5% at larger banks, according to JPMorgan Chase.
Maverick Real Estate Partners warns that the commercial property crisis is in its early stages and is likely to worsen, even if the Federal Reserve decides to cut interest rates. The report suggests that reported delinquencies are just a fraction of the defaults expected throughout 2024 and 2025, leaving banks exposed to substantial risks that a potential decline in interest rates may not resolve. The looming crisis poses a serious threat to the stability of the banking sector in the coming years.
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