The graceful art deco buildings that dominate Chicago’s central business district are reporting occupancy rates as high as 17 percent.
A set of gleaming office towers in Denver that were packed with tenants and valued at $176 million in 2013 are now largely empty and last valued at just $82 million, according to data provided by Trepp, a research firm that tracks real estate loans. Even Los Angeles’ famous buildings are about half their pre-pandemic prices.
From San Francisco to Washington, the story is the same. Office buildings remain trapped in a slow crisis. Workers sent to work from home at the start of the pandemic have not fully returned, a situation that, combined with high interest rates, is wiping out value in a large class of commercial real estate. Prices of even higher-quality office properties have fallen 35 percent from their peak in early 2022, according to data from real estate analyst Green Street.
Those forces have put the banks that hold a large chunk of America’s commercial real estate debt in the hot seat – and analysts and even regulators have said the reckoning is not yet fully settled. The question is not whether big losses are coming. It’s whether they’ll prove to be a slow bleed or a panic-inducing surge.
Last week brought a taste of the trouble brewing when New York Community Bancorp’s stock fell after the lender disclosed unexpected losses on real estate loans tied to both office buildings and apartment buildings.
So far “the headlines have moved faster than the actual anxiety,” said Lonnie Hendry, chief product officer at Trepp. “Banks are sitting on a pile of unrealized losses. If this slow leak is discovered, it could be released very quickly.”
Yesterday’s worries are today’s problems.
When a string of banks failed last spring — in part because rising interest rates had eroded the value of their assets — analysts worried that commercial real estate could cause a broader set of problems.
Banks hold about $1.4 trillion of the $2.6 trillion in commercial real estate loans due over the next five years, according to Trepp data, and small and regional lenders are particularly active in the market.
Economists and regulators feared that heavy exposure to the grim-looking industry could spook bank depositors, particularly those with savings above the $250,000 threshold for government insurance, and prompt them to withdraw their funds. .
But government officials responded strongly to the turmoil of 2023. They helped bail out failing institutions, and the Federal Reserve created a cheap bank financing option. The actions restored confidence and the bank riots died down.
That changed in recent days with the New York Community Bancorp issues. Some analysts are dismissing it as a one-off. New York Community Bancorp absorbed bankrupt Signature Bank last spring, accelerating its troubles. And so far, depositors are not pulling their money out of banks in large numbers.
But others see the bank’s plight as a reminder that many lenders are hurting, even if it doesn’t cause a system-wide panic. The government’s suspension of the banking system last year was temporary: the Fed’s funding program is due to close next month, for example. Problems in commercial real estate are persistent.
The pain has not yet been felt.
Commercial real estate is a broad asset class that includes retail, apartment buildings, and factories. The industry as a whole has had several turbulent years, with office buildings particularly affected.
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 National Bureau of Economic Research paper by Erica Xuewei Jiang from the University of Southern California, Tomasz Piskorski from Columbia Business School and two of their colleagues.
While giant 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 underestimating the potential costs.
Some offices are still officially occupied, even with few workers in them – what Mr Hendry called “zombies” – thanks to 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 no-longer-performing leases — hoping that interest rates will fall, which would help property values rise and workers return.
“If they can extend that loan and keep it performing, they can postpone the day of reckoning,” said Harold Bordwin, a principal at struggling real estate brokerage Keen-Summit Capital Partners.
Bank-reported delinquency rates remained much lower, at just over 1%, than those for market-traded commercial real estate loans, which are more than 6%. That’s a sign that lenders have been slow to recognize the buildings’ stress, said Mr. Piskorski, the Columbia economist.
Hundreds of banks are at risk.
But hopes for a recovery in the real estate office look less realistic.
Back-to-office trends have stalled. And while the Fed has signaled it does not expect to raise interest rates above their current level of 5.25 to 5.5 percent, officials have been clear they are in no rush to cut them.
Mr Hendry expects arrears could almost double their current rate to between 10 and 12 per cent 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 Fed interest rates, Mr. Piskorski and Ms. Jiang found in their paper, meaning mounting commercial real estate losses could leave many institutions in bad shape.
If this were to hurt uninsured depositors and trigger the kind of bank runs that brought down banks last March, many could be plunged into complete failure.
“It’s a confidence play and commercial real estate could be the trigger,” Mr. Piskorski said.
Their paper estimates that dozens to more than 300 banks could face such a disaster. That may not be a crushing blow in a nation of 4,800 banks — especially since small and medium-sized lenders are not as tied to the rest of the financial system as their larger counterparts. But a rapid collapse would risk a wider panic.
“There is a scenario for it to spill over,” Mr Piskorski said. “The most likely scenario is a slow bleed.”
Regulatory authorities are attuned to the threat.
Fed and Treasury officials have made it clear that they are closely watching both the banking sector and the commercial real estate market.
“Commercial real estate is an area that we’ve long known can create financial stability risks or damage to the banking system, and that’s something that requires careful supervisory attention,” Treasury Secretary Janet L. Yellen said during testimony to Congress. this week.
Jerome H. Powell, the chairman of the Fed, acknowledged during an interview with “60 Minutes” that aired on February 4 that “there will be losses.” For the big banks, Mr. Powell said, the risk is manageable. As for regional banks, he said the Fed is working with them to deal with the expected impact and that some will have to close or merge.
“It looks like a problem we’ll be working on for years,” Mr. Powell admitted. He called the problem “big” but said it “doesn’t seem to have the consequences of the kind of crisis things that we’ve seen sometimes in the past, for example, with the global financial crisis.”
Alan Rapport contributed to the report.