Commercial real estate values are a cause for concern
In the US, commercial real estate values are falling, causing concern among banks. Financial institutions are setting aside reserves to cover expected losses on loans.
Rising interest rates have led to a decline in commercial property values. The situation in the sector is being exacerbated by a trend that began during the pandemic when almost the entire world switched to remote working. Since then, most workers have never returned to their offices and demand for space has fallen.
Meanwhile, financial managers reassured investors that assets remained stable because the banks were in control. However, the market has sagged considerably, which is especially noticeable for Class B and C properties. Class A offices remain in the best position. When analysing the processes in commercial real estate, experts fear that the downturn in this sector will lead to a downturn in other sectors.
How commercial real estate values affects the banking system
In the first quarter of 2023, the profitability of financial institutions began to decline. According to Wells Fargo Bank, its delinquent commercial real estate loans have risen by almost 50% to $1.5 billion since last December. Morgan Stanley Corporation increased its provisions over the same period, citing the deteriorating economic climate and outlook for the office property sector.
Despite the growing concerns, analysts do not yet see the conditions for a banking crisis. However, they do not rule out the possibility that a number of financial institutions could face serious difficulties. For small banks, commercial property loans account for around 40% of total loans. For large financial conglomerates, the figure is around 13%.
OZK Bank reported a 10% increase in loan loss provisions in the first quarter to US$36 million. This amount is 10 times higher than the provisions for the same period in 2022.
Morgan Stanley estimates the total debt of the US commercial real estate market at US$4.5 trillion, of which about 30% is due to be repaid in 2025.
A number of experts are pointing to a 20% drop in the price of office space, causing losses not only for banks but also for investment funds. And the instability in this segment is not only observed in the US but also in other countries. In its report, the IMF notes that the global commercial real estate market requires increased attention. The worsening situation could lead to attempts to refinance loans, which in turn could lead to a wave of defaults.