Dive Overview:
Moody's Analytics said office commercial real estate values are likely to fall 26% by the end of next year as many companies downsize their workspaces or relocate to cheaper properties to adapt to the work-from-home trend. Valuations of all CRE types are likely to fall 10% from peak to trough over the next 18 months, Moody's said in a report Thursday, adding that “the office sector will be hit hardest by a large margin.” While CRE accounts for nearly a quarter of bank lending and the largest portion of bank debt, “there is ample evidence that banks are well prepared to meet the challenges ahead,” Moody's said. Still, “there is a risk that even minimal signs of stress could escalate into a broader crisis of confidence in the banking system.”
Dive Insights:
Federal Reserve Chairman Jerome Powell said this month that he expects commercial real estate losses to hit mostly smaller banks and warned that efforts to ensure stability could need to continue for years.
“Some banks are going to suffer losses,” Powell said in testimony before the House Financial Services Committee on March 6. “The concentrations of problem loans are really mid-sized and smaller banks,” he said, adding, “This is going to be a problem that we're going to have to deal with for several years.”
Federal Reserve, Treasury, bank and real estate executives have warned for months that markets could be in turmoil as property owners struggle to refinance at higher interest rates. The central bank, which aims to keep inflation at 2%, has kept its benchmark interest rate unchanged at a 23-year high since July.
In December, the Financial Stability Oversight Council, a group of major U.S. regulators, named CRE as a key risk to financial stability this year, citing rising vacancy rates, falling office property values, a possible economic slowdown and high interest rates.
Moody's said that above-average CRE debt is maturing this year and in 2025, many of which have large balloon payments that will likely need to be refinanced.
“Although interest rates are expected to decline gradually this year, borrowers may be forced to refinance at much higher rates, increasing their risk of cash-flow problems,” Moody's said.
Moody's said commercial property owners face extraordinary stress in 2022 and beyond as “rising interest rates have driven capital out of CRE and into lower-risk but newly profitable fixed-income investments.”
Moody's said the multifamily CRE subsector is likely to fall in value by 5% over the next six quarters as builders add supply.
According to Moody's, industrial and warehouse CRE could experience valuation declines of 5.7% and 6.6%, respectively, during this period. Retail CRE prices could fall 8% over the next five quarters as online shopping accounts for a larger share of total sales.
“The commercial real estate market has experienced significant turmoil in recent years,” Moody's said. “Prices have risen sharply from 2020 through 2022, initially supported by accommodative monetary policy and easing credit conditions, and later by investor demand as a hedge against inflation.”
According to the International Monetary Fund (IMF), after the Fed began raising interest rates in March 2022, CRE prices fell 11%, wiping out the gains of the previous two years.
“Furthermore, lending standards for CRE loans are becoming more stringent from mid-2022 onwards,” Moody's said.