Multiple financial dangers for the United States were identified by the Financial Stability Oversight Council, a remnant of the Dodd-Frank Act that comprises a wide range of federal banking regulators and others, in its 2023 annual report. Commercial real estate comes first on the list.
$6 trillion in loans at the top of the CRE segment as of Q2 2023, half of which are on bank balance sheets because they aren’t sold to government agencies like residential mortgages are. Furthermore, nearly half of all U.S. banks offer the greatest amount of loans in the CRE sector.
No one who has been following the market should be surprised by the concentration, especially considering that “the CRE market faced a rise in vacancy rates and declines in value for some property types, elevated interest rates, heightened CRE loan maturities, inflation in property operating costs, and an increase in CRE loan delinquencies.”
The agency expresses a concern that many in the CRE have voiced. According to the research, high interest rates raise refinancing costs for borrowers and can result in declining property values across CRE sectors. The borrower might not be eligible to refinance the loan at maturity without an additional equity infusion if the property value has significantly declined since the time of financing. As a result, the lender may suffer losses if the loan needs to be restructured or goes into default. Losses from a portfolio of CRE loans may seep into the larger financial system as they accrue.
This may lead banks to liquidate loans and real estate, further depressing values, generating a vicious cycle, and limiting credit availability. Loan distress is already evident; in the second quarter of 2022, the bank default rate increased by 0.74 percent. Delinquencies for CMBS are also higher.
Another worry is that relationships between banks, insurance providers, real estate investment trusts, and private lenders could allow bank stress to spread.
“Supervisors, financial institutions, and investors continue to closely monitor CRE exposures and concentrations and to track market conditions,” according to several recommendations made by the FSOC.
“Resilience to potential stress, ensuring adequate credit loss allowances, assessing CRE underwriting standards, and reviewing contingency planning for a possibly protracted period of rising loan delinquencies” are some of the recommendations for continuous assessment of loan portfolios.
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