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June 13, 2024

Commercial Real Estate Faces $1 Trillion Debt Cliff as Market Deteriorates

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Jan 18, 2024

A record amount of commercial real estate debt is coming due over the next few years, estimated at over $1 trillion, just as the market faces deteriorating conditions that could lead to widespread defaults. This debt cliff poses a major risk to the banking system and economy.

Over $400 Billion Maturing This Year

According to the Wall Street Journal, over $430 billion in commercial property debt from loans backed by offices, hotels, shopping centers and other retail establishments will mature in 2024 alone. This represents a 63% increase from the previous annual record set back in 2017.

Overall, nearly $1.1 trillion of commercial real estate debt will come due by the end of 2025. This wave of loan maturity comes after years of easy lending practices that left the market flooded with debt. Now the market is bracing for impact.

Property Values Dropping, Vacancies Rising

This massive debt refinancing requirement comes at a terrible time for the commercial real estate industry. Property values have already started to decline and vacancies are on the rise.

Howard Lutnick, CEO of real estate firm Cantor Fitzgerald, warned that the commercial property market is going to face very difficult conditions in 2024. “It is going to be very ugly,” he said.

According to real estate data provider Costar, property valuations fell by an average of 13% last year. The outlook remains negative going forward.

Furthermore, office vacancy rates have climbed to nearly 18% nationally. Retail vacancies are up to 11%, per data from Moody’s Analytics. This means less rental income for property owners.

Sector Vacancy Rate
Office 17.8%
Retail 11.0%

With lower valuations and higher vacancies, many property owners will struggle to qualify for refinancing at favorable rates on their maturing debt.

Surge in Distressed Assets & Defaults Expected

Industry experts are bracing for a rapid increase in distressed commercial real assets over the next two years. As borrowers fail to refinance or qualify for loan modifications on maturing debt, commercial mortgage delinquencies and defaults will mount.

“We expect distress in the commercial real estate market to increase materially,” noted Howard Marks, co-chairman of Oaktree Capital Management, one of the largest distressed debt investors globally.

Oaktree estimates that non-performing commercial loans could quadruple from current levels – exceeding losses seen even during the Great Financial Crisis of 2008-2009.

If a significant number of borrowers begin to default, it would negatively impact the capital levels of banks who hold the loans on their balance sheets. This could curtail lending activities more broadly.

Major Risks to Regional & Community Banks

The risks tied to commercial real estate debt are particularly acute for regional and community banks, who have heavy exposure to the sector.

Over 5,800 FDIC-insured banks hold nearly $2 trillion worth of commercial real estate loans on their books presently, per data from the Federal Reserve. This represents almost 20% of all outstanding bank loans.

If even a modest 5-10% of those loans begin to sour, it would deplete the loan loss provisions at hundreds of smaller banks. Analysts at Seeking Alpha estimate that over 1,000 banks could fail as a result.

During the 1990s Savings and Loan Crisis, weakness in commercial real estate lending led to over 1,400 bank failures. Thus there is notable historical precedent.

Potential Contagion Through the Banking System

Given the deep interconnectedness of the financial system, distress at regional banks has the potential to spread rapidly to larger institutions.

Just as subprime residential mortgages caused a cascading liquidity crisis back in 2008, commercial real estate could ignite contagion this time around.

“It has the potential to spiral out of control,” noted banking analyst Chris Whalen to FOX Business. “We learned back in 2008 that small failures add up over time.”

The CEO of JPMorgan Chase, Jamie Dimon, also highlighted the risk posed by commercial real estate debt maturities in his latest shareholder letter. He cautioned that the banking system is not adequately prepared to handle a potential wave of losses.

Preventative Actions Needed

In light of rising vulnerability tied to commercial real estate debt, regulators and bankers stress the need for preventative action before conditions deteriorate further.

“Financial institutions should review their CRE portfolios and risk management policies to ensure they properly assess and prepare for downside risks,” advised Federal Reserve Vice Chair Lael Brainard recently.

Likewise, Starwood Property Trust CEO Barry Sternlicht implored policymakers “to be ahead of the game” in preparing contingency plans for vulnerable property owners. Allowing widespread failures could severely harm local communities.

While the Fed and FDIC have taken initial steps to monitor risks and increase oversight of problematic banks, broader intervention may ultimately prove necessary to contain fallout – just as back in 2008-2009.

Hopefully policymakers have learned important lessons about allowing financial excesses to build unchecked, and then acting decisively when crisis strikes. The future solvency of the banking system hangs in the balance.

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AiBot scans breaking news and distills multiple news articles into a concise, easy-to-understand summary which reads just like a news story, saving users time while keeping them well-informed.

To err is human, but AI does it too. Whilst factual data is used in the production of these articles, the content is written entirely by AI. Double check any facts you intend to rely on with another source.

By AiBot

AiBot scans breaking news and distills multiple news articles into a concise, easy-to-understand summary which reads just like a news story, saving users time while keeping them well-informed.

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