Downward angle icon Downward angle icon. Commercial real estate is under pressure from rising interest rates and falling property valuations. Kena Betancur/VIEWpress Commercial real estate could suffer its biggest crash since the global financial crisis. That's bad news for banks, who could suffer an additional $160 billion in losses. That's according to a recent NBER working paper that explored the impact of the Fed's interest rate hikes.
The commercial real estate sector is at risk of its biggest crash since 2008, which could cost U.S. banks up to $160 billion in losses.
That's according to a new working paper by researchers from the University of Southern California, Columbia University, Stanford University and Northwestern University, which assesses the impact of prolonged high interest rates on the commercial real estate industry and the U.S. banking system.
The paper, titled “Monetary Tightening, Commercial Real Estate Distress, and U.S. Bank Vulnerability,” used a previously developed framework to examine the Fed's aggressive interest rate hikes in 2022, which have weighed on assets such as stocks, bonds, and commercial real estate.
Due to rising interest rates and declining property values due to remote working, it's estimated that about 14% of all loans and 44% of office loans are in a negative balance, meaning that their current value is less than the loan balance.
As a result, the report says, 10% to 20% of all commercial real estate loans could default — lower than estimated default rates during the Global Financial Crisis — and banks could suffer losses of around $160 billion.
“This evidence suggests that if interest rates remain high and property prices do not recover, default rates could reach levels comparable to or even exceeding those during the Great Recession,” the report added.
Other experts have also warned that the commercial real estate industry will be in trouble, with about $1.5 trillion in debt coming due in the next few years.
The possibility of further losses at banks is raising concerns about another bank run similar to the one that roiled Silicon Valley Bank and other financial institutions earlier this year.
In the working paper, the researchers estimated that if half of uninsured depositors emptied their accounts, between 31 and 67 small regional banks could fail due to commercial real estate-related losses, and an additional 340 banks could face failure due to losses from rising interest rates.
“If a CRE loan crisis were to materialize during the period of low interest rates in early 2022, no banks would fail even in the most pessimistic scenario. However, the large decline in bank asset values following the monetary tightening in 2022 reveals that banks' tolerance to credit risk has significantly weakened,” the researchers said. “This risk exposes banks to significant solvency risk,” the paper later added.
Investors are keeping a close eye on the stability of the U.S. banking system. In August, ratings agency Moody's downgraded the credit ratings of 10 large and mid-sized U.S. banks and put another group of banks under review, citing rising risks to bank assets.