US Commercial Real Estate Market Faces Turmoil as Lenders Brace for Defaults
The US commercial real estate market has been in turmoil since the onset of the Covid-19 pandemic. While the industry has been grappling with challenges for the past four years, the situation has intensified recently, with lenders like New York Community Bancorp feeling the pain. The bank’s decision to slash its dividend and stockpile reserves sent its stock down by a record 38%, causing the KBW Regional Banking Index to experience its worst day since the collapse of Silicon Valley Bank last March.
Adding to the property jitters, Japanese lender Aozora Bank Ltd. warned of a loss tied to investments in US commercial real estate, which sent shares plunging in Asia trading. This reflects the ongoing slide in commercial property values and the difficulty in predicting which specific loans might unravel. The pandemic-induced shift to remote work and the rapid increase in interest rates have made it more expensive for strained borrowers to refinance, further exacerbating the situation.
Billionaire investor Barry Sternlicht has even warned that the office market is headed for more than $1 trillion in losses. This grim outlook suggests that lenders may face more defaults as some landlords struggle to pay loans or simply walk away from buildings. Harold Bordwin, a principal at Keen-Summit Capital Partners LLC, emphasized that this is a significant issue that the market needs to reckon with. He pointed out that banks’ balance sheets aren’t accounting for the fact that there is a considerable amount of real estate that won’t pay off at maturity.
Moody’s Investors Service is currently reviewing whether to lower New York Community Bancorp’s credit rating to junk after the recent developments. This highlights the potential risks faced by banks, as they are looking at roughly $560 billion in commercial real estate maturities by the end of 2025, representing more than half of the total property debt coming due over that period. Regional lenders, in particular, are more exposed to the industry and stand to be hurt harder than their larger peers due to their lack of large credit card portfolios or investment banking businesses that can insulate them.
According to a report published by JPMorgan Chase & Co., commercial real estate loans account for 28.7% of assets at small banks, compared with just 6.5% at bigger lenders. This exposure has prompted additional scrutiny from regulators who are already on high alert following last year’s regional banking tumult.
While real estate troubles, especially for offices, have been apparent for nearly four years, the property market has been in limbo due to uncertainty among both buyers and sellers over how much buildings are worth. However, the need to address looming debt maturities and the prospect of Federal Reserve interest rate cuts are expected to spark more deals that will bring clarity to just how much values have fallen.
The decline in property values could be stark, as evidenced by the recent sale of the Aon Center in Los Angeles. The office tower was sold for $147.8 million, which is about 45% less than its previous purchase price in 2014.
Smaller lenders are particularly nervous due to the unpredictability of when and where soured real estate loans can occur. Just a few defaults have the potential to wreak havoc. New York Community Bancorp cited a co-op building and an office property as the reasons for its increase in charge-offs. While offices are a particular area of concern for real estate investors, the company’s largest real estate exposure comes from multifamily buildings, with the bank carrying about $37 billion in apartment loans. Nearly half of those loans are backed by rent-regulated buildings, making them vulnerable to New York state regulations passed in 2019 that strictly limit landlords’ ability to raise rents.
The pressure is growing on banks to reduce their exposure to commercial real estate. Canadian Imperial Bank of Commerce (CIBC) has recently started marketing loans on struggling US office properties. Although US office loans make up just 1% of CIBC’s total asset portfolio, the bank’s earnings were dragged down by higher provisions for credit losses in this segment.
David Aviram, principal at Maverick Real Estate Partners, warned that the percentage of loans that banks have reported as delinquent so far is just a drop in the bucket compared to the defaults that will occur throughout 2024 and 2025. He emphasized that banks remain exposed to significant risks, and the potential decline in interest rates in the next year won’t solve their problems.
The US commercial real estate market is undoubtedly facing a period of turmoil as lenders brace themselves for an increase in defaults. The ongoing slide in property values, coupled with the difficulty in predicting which loans might unravel, has created an atmosphere of uncertainty. Smaller lenders, in particular, are more exposed to the industry and stand to be hurt harder than their larger peers. As banks face looming debt maturities and the potential decline in interest rates, the market is expected to see more deals that will bring
