The near-term outlook for commercial real estate (CRE) is increasingly uncertain due to rising interest rates and concerns of a prolonged economic downturn. Banks are currently facing a worst-case scenario as rising interest rates lead to tighter credit standards and regulators put greater scrutiny on the quality of CRE loans. Tightening lending markets and a selloff in real estate investment trust (REIT) stocks suggest that CRE yield expectations are being reassessed, leading to price declines and distress for the specific asset class. If we are entering a distress cycle, it is in the early stages, with transaction volume down nearly 70% from all-time highs according to Green Street¹, making price discovery increasingly difficult. Today’s environment is more stable than the events that unfolded during the 2008 Great Recession, but dark economic clouds are beginning to gather on the horizon. So how can real estate borrowers weather a potential storm? Preparing a defensive strategy and building resilience into their portfolio’s capital structure will be key to success.
During a recent webcast, “Real Estate Distress: A Roadmap for Navigating Uncertainty,” Mark Glynis, EY Americas Real Estate, Hospitality and Construction Sector Leader, led a panel to discuss the impact of the current real estate market on lenders, borrowers and investors. The panel was made up of CRE industry experts, including restructuring, banking, tax and legal professionals.
EY analysis shows that CRE market deal volume is declining in tandem with rising interest rates, with CRE deal volume declining by approximately 70% in Q1 2023 compared to Q1 2022. EY research also shows that capitalization rates across all asset classes are rising, albeit at a slower pace relative to interest rates. Prices have fallen and are expected to continue to fall over the coming year as investors perceive CRE as increasingly risky.
The office at the center of an agonizing conversation
While issues have been concentrated in certain metropolitan areas and asset classes so far, the webcast conversation centered on emerging risks in the office sector.