The graceful Art Deco building that dominates Chicago's main business district has a low occupancy rate of just 17 percent.
A gleaming collection of Denver office towers once filled with tenants and worth $176 million in 2013 is now mostly vacant and last valued at just $82 million, according to data from Trepp, a research firm that tracks real estate loans. Even Los Angeles' famous buildings are trading for about half their pre-pandemic value.
From San Francisco to Washington, D.C., the story is the same: Office buildings remain mired in a slow-burning crisis. Employees ordered to work from home at the start of the pandemic have never fully returned, and that, combined with high interest rates, has wiped out the value of a key class of commercial real estate. Prices for even higher-quality office property are down 35% from their peak in early 2022, according to data from real estate analytics firm GreenStreet.
These forces are putting the banks that hold most of the U.S. commercial real estate debt in a bind, and even analysts and regulators say they haven't yet been held fully accountable. The question isn't whether big losses are coming, but whether they'll be a slow bleed or a panic-inducing wave.
A sign of the brewing trouble came last week when New York Community Bank's stock price plummeted after the bank revealed unexpected losses on real estate loans tied to both office buildings and apartments.
So far, “the headlines are moving faster than the actual stress,” said Ronnie Hendry, chief product officer at Trepp Inc. “Banks are sitting on huge amounts of unrealized losses. If that slow leak becomes apparent, it could be released very quickly.”
Last year's worries are today's problems.
When a string of banks collapsed last spring, partly because rising interest rates caused asset values to fall, analysts worried commercial real estate could cause more widespread problems.
Of the $2.6 trillion in commercial real estate loans maturing over the next five years, banks hold roughly $1.4 trillion, with smaller and regional lenders especially active in the market, according to Trepp data.
Economists and regulators worried that big investments in the risky industry would spook bank depositors, especially those with savings above the government-insured limit of $250,000, and prompt them to withdraw their savings.
But government officials responded forcefully to the turmoil of 2023. They helped sell failed financial institutions, and the Federal Reserve set up cheap financing options for banks. These measures restored confidence and bank fears faded.
That's all changed in recent days because of problems at New York Community Bank, which some analysts have dismissed as a one-off. The bank accelerated its troubles last spring when it absorbed the failed Signature Bank. And so far, depositors have not withdrawn funds en masse from the bank.
But some see the banks' woes as a reminder that many lenders will struggle, even if they don't trigger a systemic panic. The respite the government gave the banking system last year was temporary — the Fed's liquidity program, for example, is due to expire next month. Commercial real estate's problems are lingering.
The pain has yet to be acknowledged.
Commercial real estate is a broad asset class that includes retail stores, apartment buildings, factories, etc. The sector as a whole has been in turmoil in recent years, with office buildings being particularly hard hit.
About 14% of all commercial real estate loans and 44% of office loans are overcollateralized, meaning the property is worth less than the amount owed, according to a recent National Bureau of Economic Research paper by Erica Xuewei Zhang of the University of Southern California, Tomasz Piskorski of Columbia Business School, and two colleagues.
While large lenders including JPMorgan Chase & Co. and Bank of America Corp. have begun setting aside funds to cover expected losses, many smaller banks are downplaying the potential costs, analysts say.
Some offices are officially still occupied, even if they have few employees thanks to multi-year leases — Hendry calls them “zombies” — giving the appearance that they're operational when they're not.
In other cases, rather than take over struggling buildings or renew now-unviable leases, banks are taking advantage of short-term extensions in the hope that interest rates will fall, property values will rise and workers will return.
“If they can extend the loan and continue making payments, they can push out the closing date,” said Harold Baudouin, president of Keene Summit Capital Partners, the troubled real estate brokerage.
Banks are reporting delinquencies at just over 1% — much lower than the more than 6% rate for commercial mortgages in the market — suggesting lenders are slow to recognize mounting stress, said Piskorski, the Columbia University economist.
Hundreds of banks are at risk.
But hopes of a recovery in office real estate are looking less realistic.
The return-to-office trend has stalled, and while the Fed has signaled it doesn't plan to raise interest rates beyond their current range of 5.25% to 5.5%, officials have made clear they are in no rush to cut rates.
Hendry expects delinquency rates could nearly double to 10% to 12% by the end of the year, putting hundreds of smaller banks at risk as the financial crisis drags on.
In their paper, Piskorski and Jiang noted that the Fed's rising interest rates have caused the value of bank assets to fall, meaning commercial real estate losses could increase and many financial institutions could find themselves in distress.
If that spooks uninsured depositors and triggers runs like the ones that led to banks collapsing last March, it could lead to many banks failing outright.
“This is a trust game, and commercial real estate could be the trigger,” Piskorski said.
Their paper estimates that anywhere from a few dozen to more than 300 banks could face such collapse. In a country with 4,800 banks, that might not be a catastrophic blow, especially since smaller financial institutions are less connected to the rest of the financial system than larger ones. But a rapid collapse would risk sparking more widespread panic.
“There's a spillover scenario,” Piskorski said. “The more likely scenario is a slow bleeding scenario.”
Regulators are becoming increasingly sensitive to the threat.
Federal Reserve and Treasury officials said they were closely monitoring both the banking sector and the commercial real estate market.
“Commercial real estate is an area that has long been recognized as posing financial stability risks and losses to the banking system that require supervisory attention,” Treasury Secretary Janet L. Yellen said in congressional testimony this week.
“There will be losses,” Fed Chairman Jerome H. Powell acknowledged in an interview on “60 Minutes” that aired Sunday. He said the risks were manageable for large banks. As for regional banks, he said the Fed was working with them to deal with the expected impact, some of which would have to close or merge.
“This seems like a problem we're going to be working through for years,” Mr. Powell acknowledged. While he called the problem “fairly large,” he said it “doesn't seem to be predisposed to a crisis like we've seen at times in the past, for example the global financial crisis.”
Alan Rapeport contributed reporting.