Dive brief:
- TThe value of commercial office real estate is likely to fall by 26% by the end of next year as many companies adjust to the work-from-home trend by downsizing workspace or moving to larger properties cheap, Moody’s Analytics said.
- Valuations for all types of CRE are likely to drop 10% from high to low over the next 18 months. Moody’s said in a report Thursdayand adds that “the office sub-sector will be, by far, the most affected”.
- Although CRE represents almost a quarter of bank loans and the largest share of bank debt, “there is ample evidence that banks are equipped to meet the challenges of the future,” Moody’s said. Still, “there is a risk that even minimal signs of stress will be amplified into broader crises of confidence in the banking system.”
Diving knowledge:
Federal Reserve Chairman Jerome Powell predicted this month that CRE losses would hurt small and medium-sized banks the most and warned that efforts to ensure stability would need to persist for many years.
“There will be losses on the part of some banks,” Powell said in testimony to the House Financial Services Committee on March 6. “It’s really the medium and small banks that have these higher concentrations” of bad loans, he said, adding that “it’s going to be an issue that we’re going to be working with, I think, for a number of years.”
TThe Fed, Treasury, bankers and CRE executives have warned for months of potential market turmoil as homeowners scramble to refinance debt at higher rates. The central bank, which seeks to curb inflation at 2%, has kept the benchmark interest rate at a 23-year high since July.
The Supervisory Council of Financial Stability of major US regulators in December singled out CRE as the top risk to financial stability this year, pointing to rising unemployment rates, declining office property values, the possibility of an economic slowdown and high interest rates.
A higher-than-average amount of CRE debt will mature this year and in 2025, with many loans with large balloon payments likely to need to be refinanced, according to Moody’s.
“Even with interest rates expected to fall this year, borrowers will have to refinance at a much higher interest rate, increasing the risk of cash flow problems,” Moody’s said.
Commercial property owners have faced unusual stress since 2022 as “higher interest rates have driven capital away from CRE in favor of lower-risk, but recently lucrative, fixed income investments Moody’s said.
The value of the multifamily CRE subsector will likely decline 5% over the next six quarters as builders increase supply, Moody’s said.
Industrial and warehouse CRE are likely to suffer a 5.7% and 6.6% decline in valuation over the period, respectively, according to Moody’s. CRE retail prices are likely to fall 8% over the next five quarters as online shopping takes a bigger share of global sales.
“The commercial real estate market has undergone significant change in recent years,” Moody’s said. “Prices soared between 2020 and 2022, driven initially by easy monetary policy and loose credit conditions, and then by investor demand as a hedge against inflation.”
BELIEVE then prices fell by 11% after the Fed began raising interest rates in March 2022, erasing the gains of the previous two years, according to the International Monetary Fund.
“In addition, lending standards for CRE loans have been tightened since mid-2022,” Moody’s said.
