The commercial real estate industry is in a slump, and it could drag the financial sector down with it, according to a new report from Florida Atlantic University (FAU).
The root of the problem is the COVID-19 pandemic, which has caused commercial real estate holdings to fall in value due to the shift to remote work, while coronavirus-induced inflation and the resulting rise in interest rates are also putting stress on banks' holdings.
With data through the fourth quarter of 2023, FAU reported on the potential for commercial real estate to be a liability for the nation's largest banks in February 2024. Now that the first quarter of 2024 has passed, FAU's Banking Initiative has released a new analysis by Dr. Rebel Cole, professor of finance in the FAU College of Business. This “screener” looks at the nation's largest banks and compares their total capitalization to their exposure to commercial real estate.
Of the 157 banks surveyed in the screener, 67 banks have commercial real estate exposure of more than 300% of their total capital. For reference, the current industry average places banks' commercial real estate exposure above 139% of their total capital. This average highlights just how embedded commercial real estate is in financial institutions' economically-supporting portfolios.
New York-based Dime Community Bank had the highest commercial real estate exposure to capital ratio, with $9.2 billion in exposure and $1.4 billion in capital, a difference of 653.7%.
According to Dr. Cole, the weakest banks in the study are Flagstar Bank (ranked 6th) and Zions Bank (ranked 22nd). Flagstar has just $9.3 billion in capital and $51 billion in commercial real estate exposure (a difference of 553%). Zions has $26 billion in commercial real estate exposure and just $5.8 billion in total capital (a difference of 439.7%).
“These are two large banks with excessive exposure to commercial real estate,” Dr. Cole said in a statement. “Both banks are heavily reliant on uninsured deposits, making them vulnerable to bank runs similar to those that forced regulators to close three large banks in the spring of 2023. These bank closures raise concerns about the stability of the U.S. banking system to this day.”
Cole points out that excessive exposure to commercial real estate isn't limited to large banks: 1,871 banks of all sizes have a combined CRE exposure of more than 300%. According to the FDIC, a ratio above 300% is considered excessive CRE exposure, which increases the risk of a bank failing.
“Three banks have failed in the past year and there are now multiple candidates with over 500% exposure to commercial real estate,” Cole said. “If additional banks were to fail, depositors would likely pull their money out of these highly exposed banks, which could lead to a banking panic similar to what we saw in the spring of 2023.”
The three banks Cole is referring to are Heartland Tri-State Bank (closing in July 2023), Citizens Bank (closing in November 2023), and Republic First Bank (closing in April 2024). Republic Bank's assets were absorbed by Fulton Bank (minimizing the damage from this closure), but experts say this failure means more bank closures are very likely.
Proposals to mitigate the crisis include reusing and restoring value to commercial real estate buildings. Boston, for example, has launched a pilot program to offer tax incentives to developers who convert vacant commercial buildings into apartment complexes.
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For more information, see FAU's full report here.