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Has the commercial real estate industry been sacrificed at the altar of home-brewed coffee and lunchtime walks with the family dog?
With a $1.5 trillion wall of debt coming due before the end of 2025 and a litany of external challenges facing property owners, some analysts are sounding the alarm that instability in commercial real estate could deliver the next shock to the economic system.
A Vacant Stare
If some sectors have faced death by a thousand cuts, the commercial real estate story has looked more like a scene from Kill Bill. Couple work-from-home and “quiet quitting” on the demand side with a deep pool of vacancies on the supply side, and it’s easy to see why people are breaking out the worry beads.
It gets worse. More than half of the $5.6 trillion of all outstanding commercial loans sit on the books of American banks, according to a Goldman Sachs note published last month. And not just any banks. Small and regional lenders, the same banks that you might remember made a few headlines in recent months, are holding the majority of this paper. That leaves property owners with few willing lenders ahead of debt repayments just as building valuations crash amid all-time high vacancy rates (some 18% of office space sat empty by late 2022, according to brokerage giant Cushman & Wakefield).
Frantic analysts, unsurprisingly, are screaming and pointing at what they see as a bubble bursting… or an asteroid striking… or whatever other economic-disaster imagery you may prefer:
- Overall, the valuations of office and retail properties could plummet by as much as 40%, Morgan Stanley analysts wrote in a note last week, flagging the risk of defaults.
- “Refinancing risks are front and center,” the analysts wrote. “The maturity wall here is front-loaded. So are the associated risks.” Making everything worse, the analysts say, is the banks’ dual role as lenders and buyers.
B for Busted: Most analysts say the pain will not be felt equally. Employers, still desperate for the imagined inspiration spurred by water-cooler chit-chat, have focused on finding and upgrading office space to rival the comfort of the couch. That leaves Class B space to absorb the brunt of the downslide, while the industry’s reliance on regional banks may offer natural roadblocks to contagion (the tax base of municipalities — where Class B space will continue to sit empty — may have reason to be concerned, on the other hand). Other spaces, like warehouses and rentals, remain strong. The S&P United State REIT Index, which fell precipitously in the weeks post-SVB collapse, has recovered most of its losses and is now up on the year. That leaves some hope for a crisis being averted. Then again, 2023 has been all about Murphy’s Law.