After announcing his first pause in interest rate hikes since March last year, Federal Reserve Chairman Jerome Powell told reporters he was watching commercial real estate and monitoring the situation as it unfolds. concerning the banking system “very carefully”.
“There is a significant amount of commercial real estate in the banking system; much of it is in small banks,” Powell told reporters on Wednesday. “To the extent that it is well distributed, the system could suffer losses. We expect there will be losses, but there will be banks that will have concentrations, and those banks will suffer greater losses. So we are well aware of this, we are monitoring it carefully.
Estimates of the concentration of commercial real estate debt in smaller banks vary, but Goldman Sachs has previously suggested that lenders with less than $250 billion in assets account for about 80% of commercial real estate loans. After the bank failures, the focus seemed to shift to commercial real estate and the sector’s relationships with banks. After all, commercial real estate made up 45% of the loan portfolios of Signature Bank, which sank in the wake of the collapse of Silicon Valley Bank. Still, Powell seemed to think the risk was contained, at least for now.
“It looks like something that will be around for a while, as opposed to something that will suddenly hit and head into systemic risk,” Powell said, after stressing that the Fed is aware of the situation and is monitoring it closely. . Powell later said that if conditions tighten enough, that could factor into Fed rate decisions going forward.
Everything that’s happening with commercial real estate is because the sector is vulnerable to high inflation and high interest rates, especially because it’s so heavily debt-based. It has therefore become more difficult and expensive for borrowers to obtain a loan or to refinance an existing loan once it has matured. As The wealth previously reported, the current environment of higher interest rates coupled with tighter lending standards (following bank failures), will likely lead to increased delinquencies and defaults.
However, while there are sub-sectors of commercial real estate that appear to be holding up (such as industrial and multi-family), office space is most at risk. This is because of the lack of demand following the shift to working from home. As Fortune previously reported, a commercial real estate executive called what is happening in the office sector “apocalyptic”, saying it is already falling apart.
Along the same lines, and in a similar apocalyptic way, analysts at Morgan Stanley “expected CRE prices to decline by up to 40%, worse than during the Great Financial Crisis.” Meanwhile, analysts at Goldman Sachs and UBS tend to suggest that the risk ahead is largely confined to the office sector, as it faces rising vacancy rates and falling property values.
This story was originally featured on Fortune.com
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