by The elegant art-deco buildings towering over Chicago’s key business district report occupancy rates as low as 17 percent.
A set of gleaming office towers in Denver that were packed with tenants and worth $176 million in 2013 are now virtually empty and were last appraised for just $82 million, according to data provided by Trepp, a research firm that track real estate loans. Even famous Los Angeles buildings are reaching about half their pre-pandemic value prices.
From San Francisco to Washington, DC, the story is the same. Office buildings remain stuck in a slowly advancing crisis. Employees sent to work from home at the start of the pandemic have not fully returned, a situation that, combined with high interest rates, is killing the value of an important class of commercial real estate. Prices for even higher-quality office properties have fallen 35 percent from their early 2022 peak, according to data from real estate analytics firm Green Street.
Those forces have put banks that hold much of America’s commercial real estate debt in trouble, and analysts and even regulators have said the reckoning has not yet fully taken hold. The question is not whether big losses are coming. The question is whether they will turn out to be a slow bleed or a panic-inducing wave.
Last week brought a taste of the trouble brewing when shares of New York Community Bancorp plunged after the lender disclosed unexpected losses on real estate loans tied to both office and apartment buildings.
So far, “the headlines have moved faster than the actual stress,” said Lonnie Hendry, chief product officer at Trepp. “Banks have a lot of unrealized losses. “If that slow leak is exposed, it could release very quickly.”
Last year’s worries are today’s problems.
When a series of banks failed last spring (in part because rising interest rates had reduced the value of their assets), analysts feared that commercial real estate could trigger a series of broader problems.
Banks hold about $1.4 trillion of the $2.6 trillion in commercial real estate loans that come due over the next five years, according to Trepp data, and small and regional lenders are especially active in the market.
Economists and regulators feared that heavy exposure to this seemingly dangerous industry could scare bank depositors, particularly those with savings above the $250,000 limit for government insurance, and prompt them to withdraw their funds.
But government officials responded forcefully to the turmoil of 2023. They helped liquidate failing institutions, and the Federal Reserve created a cheap bank financing option. Stocks restored confidence and bank jitters faded from view.
This has changed in recent days with the problems of the New York Community Bancorp: some analysts dismiss it as something exceptional. New York Community Bancorp absorbed the failed Signature Bank last spring, accelerating its problems. And so far, depositors are not taking their money out of banks in large amounts.
But others see the bank’s plight as a reminder that many lenders are struggling, even if it doesn’t spark system-wide panic. The respite the government provided to the banking system last year was temporary: the Federal Reserve’s funding program is ready to close next month, for example. Commercial real estate problems are long-lasting.
The pain has not yet come true.
Commercial real estate is a broad asset class that includes retail, multifamily housing, and manufacturing. The sector as a whole has had a tumultuous few years, and office buildings have been especially hard hit.
About 14 percent of all commercial real estate loans and 44 percent of office loans are underwater, meaning the properties are worth less than the debt behind them, according to a recent article from the National Bureau of Economic Research by Erica Xuewei Jiang of the University of Southern California, Tomasz Piskorski of Columbia Business School, and two of their colleagues.
While large lenders such as JP Morgan and Bank of America have begun setting aside money to cover expected losses, analysts said many small and medium-sized banks are downplaying the potential cost.
Some offices are still officially occupied even with few workers in them (what Hendry called “zombies”) thanks to years-long lease terms. This allows them to appear viable when they are not.
In other cases, banks are using short-term extensions rather than taking over distressed buildings or renewing leases that are now unviable, in the hope that interest rates will fall, which would help raise the value of properties and for workers to return.
“If they can extend that loan and keep it going, they can postpone the day of reckoning,” said Harold Bordwin, principal at troubled real estate brokerage Keen-Summit Capital Partners.
Delinquency rates reported by banks have remained stable Much lowerjust above 1 percent, than those in Commercial real estate loans that are marketed. in the markets, which exceed 6 percent. That’s a sign that lenders have been slow to recognize the strains on construction, said Piskorski, the Columbia economist.
Hundreds of banks are at risk.
But hopes for a recovery in the office real estate sector seem less realistic.
Back-to-office trends have plateaued. And although the Federal Reserve has signaled that it does not expect to raise interest rates above their current level of 5.25 to 5.5 percent, officials have made clear that they are in no rush to cut them.
Hendry expects bad debts to almost double from their current rate to between 10 and 12 percent by the end of this year. And as the reckoning progresses, hundreds of small and medium-sized banks could be at risk.
The value of bank assets has taken a hit amid higher Federal Reserve rates, Piskorski and Jiang found in their paper, meaning mounting commercial real estate losses could leave many institutions in poor condition.
If that were to unsettle uninsured depositors and trigger the kind of bank runs that brought down banks last March, many could sink into total failure.
“It’s a trust game, and commercial real estate could be the trigger,” Piskorski said.
Their paper estimates that anywhere from dozens to more than 300 banks could face such a disaster. That may not be a crushing blow in a nation with 4,800 banks, especially since small and medium-sized lenders are not as connected to the rest of the financial system as their larger counterparts. But a rapid collapse would risk triggering broader panic.
“There is a scenario where this boils over,” Piskorski said. “The most likely scenario is slow bleeding.”
Regulators are attuned to the threat.
Federal Reserve and Treasury Department officials have made clear that they are closely monitoring both the banking sector and the commercial real estate market.
“Commercial real estate is an area that we have long known could create risks to financial stability or losses in the banking system, and this is something that requires careful supervisory attention,” said Treasury Secretary Janet L. Yellen, during testimony before Congress this week.
Jerome H. Powell, chairman of the Federal Reserve, acknowledged during an interview on “60 Minutes” broadcast on February 4 that “there will be losses.” For big banks, Powell said, the risk is manageable. As for regional banks, he said the Federal Reserve was working with them to deal with the expected fallout, and that some would have to close or merge.
“It seems like a problem we’ll be working on for years,” Powell admitted. He called the problem “considerable” but said it “does not appear to have the makings of the kind of crisis we have seen at times in the past, for example with the global financial crisis.”
Alan Rappeport contributed reports.
