If you’re waiting for the commercial real estate apocalypse to hit, it could be a while, maybe forever.
Why is this important: Commercial real estate, particularly the office sector, is plummeting – and regional banks lending to space aren’t looking so hot either – raising fears of a “catastrophic loop.”
- “There has certainly been an overreaction in the market regarding the relationship between banks and CRE [commercial real estate]“said Kevin Fagan, senior director and head of economic analysis CRE at Moody’s Analytics.
Catch up fast: Market watchers have been spooked by Federal Reserve data showing commercial real estate loan holders are a highly concentrated group – with smaller regional US banks (those not in the top 25) collectively owning 67%.
Reality check: This mind-boggling number turns out to be a bit misleading. Under the hood, the situation is more nuanced, as detailed in two reports from the Mortgage Bankers Association And Moody’s Analytics.
- The 67% figure includes loans backed by traditional commercial real estate – apartment complexes, office buildings, retail space – but it Also includes construction loans, loans backed by farmland, or loans to owner-occupied properties such as two-family homes.
State of play: The traditional commercial real estate loan market is incredibly diverse. This means borrowers should have options when it comes time to refinance.
- Banks – large and small – account for 39% of outstanding loans, according to Moody’s Analytics.
- Regional banks only hold 14% of outstanding loans.
- Fannie Mae and Freddie Mac also make a lot of these loans, as do life insurance companies. (The table above shows the breakdown.)
Zoom out: Regardless of the makeup of lenders, it is certain that the commercial real estate market will struggle in the coming years, likely due to the growth distress in the office building segment.
- Office loans represent approximately 17% of outstanding commercial real estate debt, as calculated by the MBA.
- Rents are not what they used to be and the value of buildings will fall.
- With a glut of loans coming due soon, some are sure to default. Morgan Stanley estimates than $1.5 trillion in commercial real estate debt is expected to mature within the next two years.
But, but, but: “These are not systemic risks to the overall economy,” Fagan says.
- On the one hand, similar to what happened in the residential mortgage market, underwriting standards improved after the global financial crisis.
- Specifically, loan-to-value (LTV) ratios are much lower now, as shown in the chart below. This means that borrowers have more equity (and correspondingly smaller loans) in their properties.
- This will help when it’s time to refinance those loans. Borrowers may still have a chance to make new loans, despite falling property values and rising interest rates.
- And when defaults do occur, lower LTVs should mean lower losses for lenders.