Senior officials said this week that US banks are becoming increasingly concerned about falling commercial property valuations and the risks to lenders’ balance sheets.
Rising interest rates and the preference of many employees to work from home especially since the coronavirus pandemic has led to a decrease in office valuations.
However, financial authorities sought to reassure investors that they do not expect significant systemic risk as the holdings are largely distributed among banks and other institutions.
“What happens to commercial real estate, particularly offices” was State Street’s biggest concern, US Custody Bank Chief Executive Officer Ron O’Hanley said this week. Not all properties were hit equally, he said: “Class A is holding up. Rents may be down but they are not in trouble. Class B and C absolutely are.
“The question we all have is whether infection will spread through the office sector,” said Brian McDonnell, head of PGIM’s real estate lending business. “If you get to a trust issue, all of a sudden, people can put all commercial real estate in the same bucket.”
There are signs of increasing pressure in Q1 bank earnings. Last week Wells Fargo reported that its non-performing commercial real estate loans had risen nearly 50 percent from December to $1.5 billion. Morgan Stanley cited commercial assets and a deteriorating economic outlook as reasons for the sharp increase in its provisioning over the previous year.
“In my view we are not in a banking crisis, but we have had, and may still have, a crisis among some banks,” Chief Executive Officer James Gorman told analysts on a call.
Commercial real estate loans account for about 40 percent of small banks’ total lending, compared to about 13 percent of the largest lenders’ books.
Arkansas-headquartered bank OZK, which has heavy exposure to the sector, reported Friday that it had increased loan provisions by 10 percent in the first quarter. at $36mn, which is ten times higher than the year-ago level.
Nearly a third of the $4.5tn in commercial real estate debt comes due before the end of 2025, according to Morgan Stanley analysts, who described it as “front-loaded”.
This week, Christopher Ellman, chief investment officer for the $306 billion California State Teachers Retirement System, told the Financial Times that he estimates office values have declined by about 20 percent and that he is looking at the fund’s $52 billion real estate portfolio. Be prepared for heavy losses. ,
Investor jitters are spreading fast, with nearly half of those surveyed this month by Bank of America identifying commercial real estate as the most likely source of a systemic credit event.
The sector is causing similar concerns beyond the US, with a top IMF official this month describing commercial property as a “point of focus”.
The multilateral lender’s latest financial stability report warned how a toxic combination of declining asset values, tighter financial conditions and illiquid markets could see borrowers struggle to refinance growing stocks of maturing loans, leading to increasingly high defaults. The rate can be
Property group Brookfield this week added to a growing number of high-profile defaults by walking away from a $161 million loan involving a cluster of mostly suburban office buildings near Washington. In February, it returned the keys to two major Los Angeles office towers.
Blackstone and PIMCO have also dumped some of their office investments in recent months, instead continuing to hold loss-making bets.
“If you have matured debt, you can’t afford the current debt load and you’re not willing to put down more money, it’s foreclosure,” said Tony Natsis, head of the real estate group at the law firm Allen Matkins.
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He said, however, that lenders would prefer to modify existing loans: “They’re asking themselves ‘do I really want to take this back in a bad market?’
In the first three months of this year, office-related deals fell to their lowest levels in more than a decade, according to data from MSCI Real Assets.
Real estate experts are at pains to point out that commercial property is a slow-moving, lumpy market and investors shouldn’t expect quick solutions to troubling situations – or lenders to pile on fast for those difficulties. And borrowers try to potentially work out solutions.
“The positive is that large parts of commercial real estate are still performing quite well, such as logistics, hotels, rental housing and data centres,” said Jonathan Gray, chairman of Blackstone, the world’s largest property investor with $332bn in real estate. With property assets, said this week.
Gray made his name through Blackstone’s property arm and emphasized how widely organized real estate investments were.
“Commercial real estate is roughly distributed among large banks, small banks, insurance companies, government agencies, securitization and mortgage REITs,” he said. “I don’t think it’s the kind of systemic issue that people are saying.”
Reporting by Jennifer Hughes, Brooke Masters, Harriet Clerfelt, Madison Derbyshire, Antoine Gara and Stephen Gandel in New York and Colby Smith in Washington
