Looming Commercial Real Estate Crisis

Author: Steve Tee

It is general knowledge now that many small medium regional US banks are in deep waters with their oxygen tank running low in O2. Also, they are the majority lenders to commercial real estate, be it retail or office. Adding fuel to the burning flame, which is rising interest rates, rising cost of materials for maintenance/renovation, remote work trending, companies of all sizes are laying off staff en masse and closing down plants, warehouses and even manage corporate offices, and bank runs continue to increase pace as fear and anxiety escalates.

A Morgan Stanley analyst says commercial real estate is headed for a crisis worse than 2008, reported by Yahoo Finance. In this article, it is stated that Brookfield, largest office owner in downtown L.A., chose to default on loans on two buildings rather than refinance the debt due to weak demand for office space, in February 2023. This is early signs of catastrophe as there a whopping nearly $1.5T commercial real estate debt tsunami due for repayment before end of 2025, as reported by Yahoo Finance.

In Canada, it was reported by Financial Post that the national office vacancy rate hit an all-time high in Q1 of 2023, according to CBRE. This real estate firm also shed more disturbing data, in which Toronto’s downtown office vacancy rate reached 15.3%, highest level since 1995 and in Vancouver’s downtown office vacancy rate rose to 10.4%, highest level since 2004. Ottawa and Montreal both recorded all-time high downtown office vacancy rates of 13.2% and 16.5% respectively. These data on 4 metropolitan areas (Toronto and Vancouver being 2 largest) in Canada, is the bellweather for what’s to come.

Money has been dirt cheap for far too long, baiting real estate developers and investors to pile into this lucrative sector; and all of a sudden, interest rates raised at record pace and supply chain shocks causing inflation on materials. According to Market Insider, more than 50% of $2.9T in commercial mortgages will need to renegotiated in the next 24 months when new lending rates are likely up by 350 to 450 basis points, says Lisa Shallett. She also mentioned that high borrowing cost and tightening credit conditions caused by banking turmoil could raise hurdles for big real estate investors as they seek to refinance a pile of loans.

Regional banks have the highest and most dangerous exposure now, reason being 80% of US commercial real estate debt outstanding are held in small-medium size banks. They will be the first one to go, but definitely not the last.