Will the U.S. Commercial Property Meltdown Lead to a Banking Crisis?

The turmoil in the U.S. commercial real estate market is already negatively affecting banks that hold a large amount of debt of struggling property developers.  With the surge in interest rates, many property developers are struggling to refinance their debts, forcing some banks to boost their reserves for loan losses.  U.S. banks held about $2.7 trillion in commercial and real estate loans as of Q3 of last year, according to a report prepared for the National Bureau of Economic Research (NBER).

According to the NBER report, about 14% of all commercial real estate loans and 44% of loans on office buildings appear to be in a negative equity position, meaning the debt is greater than the property value.  That increases the risk that borrowers won’t repay and will default on their loans. According to analytics firm Green Street, commercial property values have fallen -22% since Q1 of 2022, when the Federal Reserve began raising interest rates.   Also, office prices have tumbled -35% as demand for office space weakened following the adoption of remote work.

Some banks are beginning to feel the heat from the commercial property crisis.  New York Community Bancorp (NYCB), which acquired part of Signature Bank last year, plunged more than -37% on Wednesday to a 23-year low after slashing its dividend and raising its provision for loan losses to $552 million, largely due to exposure to commercial property loans.  Also, Japan’s Aozora Bank plunged more than -20% today after warning of a loss to investments in U.S. commercial property.  In addition, Deutsche Bank AG today more than quadrupled its U.S. real estate loss provisions to 123 million euros ($133 million) in Q4 from a year earlier.

On Tuesday, billionaire investor Barry Sternlicht said he sees more than $1 trillion of losses for office real estate and called the properties “one asset class that never recovered” from the pandemic.  Sternlicht said that regional banks have previously been a source of funds for real estate owners, but they have now disappeared from the market.  Keen-Summit Capital Partners LLC said the prospects of more defaults have intensified and warned, "Banks’ balance sheets aren’t accounting for the fact that there’s lots of real estate on their books that are not going to pay off at maturity.”

According to a report from Trepp, banks are facing roughly $560 billion in commercial real estate maturities by the end of 2025.  Regional banks are more exposed to the industry and stand to be hurt harder than more-capitalized big money center banks because they lack the hefty credit card portfolios or investment banking businesses for insulation.  According to JPMorgan Chase, commercial real estate loans account for 28.7% of assets at small banks, compared with just 6.5% at bigger banks. 

Maverick Real Estate Partners warns that the commercial property crisis has just begun and will worsen even if the Fed starts cutting interest rates, saying that “the percentage of loans that banks have so far been reported as delinquent are a drop in the bucket compared to the defaults that will occur throughout 2024 and 2025. Banks remain exposed to these significant risks, and the potential decline in interest rates in the next year won’t solve bank problems.”

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