Is Office Real Estate the Next Systemic Risk?

Banks’ exposure to the $20 trillion commercial real estate market—particularly office buildings—is taking center stage in the media as the liquidity crisis wanes.

Higher interest rates. Crashing property values. Soaring vacancy levels (thanks in part to the continued prevalence of remote and hybrid work). It’s all prompting concerns about the amount of riskthat may be lurking in CRE.

“Although this is not yet a systemic problem for the banking sector,” Cornell University economist Eswar Prasad told CNN, “there are legitimate concerns about contagion.”

• The Picture for Small Banks: While all lenders are on alert, an American Banker report suggests CRE could be “a ticking time bomb” for community and regional banks. They hold about $2 trillion in CRE debt. That includes, says CNN, a record $270 billion in commercial mortgages scheduled to mature this year—$80 billion in office properties.
• One Market’s Experience: The Seattle Times zooms in on the Emerald City, where developers are pressing pause on apartment projects, office buildings are struggling to keep tenants, and permit applications for new construction have stalled. Higher interest rates and risk aversion have caused more deals to fall though. “It’s a tougher lending environment to get construction loans right now,” said one local loan officer. “Lenders are just being super selective.”
• ‘Doom’ Scenario: If CRE problems persist, the CNN article warns, a possible worst case is a “doom loop” where growing distrust in banks with considerable commercial real estate loan exposure leads to a run on deposits. That would force banks to demand repayment on loans, “exacerbating the sector’s downturn and further damaging the banks’ financial position”—thus leading to more bank runs. That’s “not the central expectation right now,” though, the article says.
• The Good News? CNBC’s The Bottom Line blog also pumps the breaks on the doom and gloom, noting that the office sector is only one part of the CRE space—albeit a sizable one—and the others are in “unusually good shape.” Vacancy rates in warehouse, industrial, and retail spaces are low, and hotels are setting post-COVID pandemic records for revenue per available room.