Downward angle icon Downward angle icon. Exterior of 55 Broad Street in Manhattan, which is being converted from office to residential. Joe Woolhead Commercial real estate prices are in the midst of their biggest decline in half a century, according to the IMF. Real estate prices have typically remained stable or fallen slightly during previous interest rate hike cycles. Today's price slump is due to a sudden tightening of credit and a trend towards remote work that is driving down office prices.
The International Monetary Fund said U.S. commercial real estate prices are experiencing one of the sharpest declines in the past half century, easily exceeding the declines seen during previous interest rate-hiking cycles.
U.S. commercial real estate prices have fallen more than 11% since the Federal Reserve raised interest rates for the first time in March 2022, the agency said in a blog post. As the federal funds rate has risen from near-zero levels to a range of 5.25% to 5.5%, real estate price gains recorded over the past two years have completely disappeared.
While tight monetary policy often leads to weaker demand and falling values, the current rate of decline is striking, the analysts, led by Andrea Deggi, wrote.
“As this week's chart shows, in contrast to the current policy cycle, commercial real estate prices have generally remained stable or only declined to a lesser extent during previous periods of Fed rate hikes,” they said. “However, some of the previous rate hikes, such as those from 2004 to 2006, followed by recessions and larger declines in commercial real estate prices as demand slumped.”
According to IMF data, today's trend most closely resembles the trajectory of price declines recorded in 1983-1984 and 1988-1989, when values fell 5.86% and 2.71%, respectively.
International Monetary Fund
The magnitude of today's decline is due in part to the unusually rapid pace of tightening that is occurring in the current cycle. As the Fed raised interest rates sharply, mortgage rates and commercial mortgage-backed security yields also spiked as a result of stress in the sector.
Meanwhile, rising borrowing costs have also hit private equity funding, the sector's main source of funding, while tougher lending standards between banks have only deepened the credit crunch.
“For example, nearly two-thirds of U.S. banks recently reported tightening lending standards for commercial construction and land development loans, up from less than 5% early last year,” the blog said.
Additionally, pandemic-era trends of remote work and e-commerce have dampened demand for the office and retail sectors, with these property types suffering the highest delinquency rates. The office market in particular is feeling the pain, as remote work appears to be a lasting legacy of the COVID era, dampening demand for space.
The Federal Reserve is expected to start cutting interest rates later this year, but Wall Street is increasingly worried that a wave of defaults could soon hit commercial real estate, especially with more than $1 trillion in debt maturing in the next two years.
In a worst-case scenario, commercial real estate assets could be worth $1 trillion, according to Cantor Fitzgerald CEO Howard Lutnick.
“Financial supervisors must remain vigilant: rising delinquencies and defaults in this sector could restrict lending and trigger a vicious cycle of tightening financing conditions, falling commercial property prices, and losses for financial intermediaries, with adverse effects on the broader economy,” the IMF warned.