Dive brief:
- TThe possibility of large losses in the $24 trillion U.S. commercial real estate market poses a top risk to financial stability, the Federal Reserve said, pointing to rising vacancy rates and slowing rent growth.
- “A correction in office property valuations accompanied by even a mild recession could result in significant losses for a number of financial institutions with significant exposure, including some regional banks and insurance companies,” the Fed said in its quarterly. Financial stability report.
- Three out of four analysts at financial services firms ranked real estate as the top threat to financial stability, tied with inflation and up from fourth place in May, the Fed found in a survey. “There will be sure loss,” Fed Chairman Jerome Powell said in an interview this Thursday. “You can drive down most downtowns, a lot of downtowns anyway, and see empty buildings.”
Diving knowledge:
TThe commercial real estate market has fallen in recent years as working from home increased in popularity and borrowing costs rose.
From March 2022, Fed policymakers, aiming to curb the worst inflation in four decades, raised the benchmark interest rate from near zero to a range between 5.25% and 5.5%, a maximum of 22 years.
Meanwhile, commercial property prices fell 3.9% from the second quarter of last year to the second quarter of 2023, well below the average annual growth of 3.3% from 1997 to the second quarter , said the Fed.
According to the Fed, “commercial real estate valuations are particularly high for the office sector, where fundamentals are particularly weak for offices in central business districts, with vacancy rates rising further and rent growth declining since the May report.”
Banks reported an increase in standards and a fall in demand for all categories of commercial real estate loans in the first half of this year, the central bank said, citing its survey of senior loan officers.
“Commercial real estate is not a primary risk, not a major risk, for the larger banks,” Powell said in the interview. Regional and smaller banks “have proportionally much greater exposure to real estate.”
“What we’ve done is the supervisors are out there looking at the real estate portfolios, they’re working with the banks to make sure they have plans to deal with the problems they have in their portfolios,” he said. “We’re on this case.”
Financial instability could also erupt if price pressures persist and prompt the Fed to further tighten monetary policy, according to the brokers, investment funds, research firms and other analysts of financial services firms surveyed by the central bank.
Following the increase in the federal funds rate, many companies will have to refinance debt at much higher interest rates than were common just two years ago.
The outlook for borrowing has worsened in recent weeks, with some companies’ balance sheets straining.
Since policy makers met on September 19-20, the yield on the 10-year Treasury note rose about 0.5 percentage points to 4.8%.
The yield, the benchmark for corporate bonds, auto loans, mortgages, student loans and other financing, topped 5% on Monday for the first time in 16 years before retreating. Started 2023 around 3.8%.
“A sharp increase in rates could lead to increased volatility in financial markets, strains for market liquidity and an adjustment in asset prices,” the Fed said.
