US vacant offices raise concerns about commercial real estate investments, banking sector

WASHINGTON/NEW YORK 

Offices in the US are increasingly becoming vacant as the remote working model becomes widespread, causing offices’ value to dwindle, and concerns for banks whose portfolios are dominated by commercial real estate loans.

The national office vacancy rate in the US reached a record 19.6% in the fourth quarter, according to data from the US-based credit agency, Moody’s Analytics.

Declining demand due to office vacancies caused property values to decrease, and rising interest rates in the face of inflation weakened the commercial real estate market, which consists of office buildings, restaurants, or retail outlets worth $20 trillion in size.

Despite the full or part-time returns to offices post-pandemic, rising interest rates hiked the possibility of real estate loan defaults and reduced demands for new projects.

Commercial real estate loans account for more than one-fourth of an average bank’s assets, and the concentration of such assets is of note in the portfolio allocations of some regional banks.

Although the situation poses a risk for banks that hold most commercial real estate loans, it can also affect the general public whose local governments depend on property tax revenues and whose retirement portfolios include real estate assets.

With more than $1 trillion in commercial real estate loans expected to mature in the next two years, there is concern about how a crisis in the sector would affect the US banking sector and the economy in general.

NYCB’s surprise loss reignites concerns

As the New York Community Bank (NYCB) announced its balance sheet at the end of January, the bank’s problems have reignited fears about commercial real estate around the world.

The NYCB’s loss due to problematic real estate loans and dividend cuts caused a decline of more than 55% in its shares, contrary to the bank’s expectations.

Moody’s downgraded NYCB’s long-term credit rating, leaving it on watch for further downgrades, citing the concentration of commercial real estate loans in the bank’s portfolio.

The NYCB acquired the assets of Signature Bank, which went bankrupt in 2023, and the US Federal Deposit Insurance Corporation (FDIC) announced that Signature Bank’s loan portfolio consisted primarily of commercial real estate and commercial loans.

The Aozora Bank in Japan and the Deutsche Pfandbriefbank in Germany, which have risks tied to their commercial real estate portfolio in the US, were also hit by the negative headwind.

Commercial real estate investment at lowest since 2012

Commercial real estate market investments in the US have seen a sharp decline of 52% to $348 billion over the past year, according to data from the US-based investment firm, CBRE.

New York was the leading market in terms of investment volume last year with $33 billion, followed by Los Angeles with $30 billion and Dallas at $18 billion.

Vacant office rates expected to rise

The deterioration in the commercial real estate market will increase in 2024, led by office properties, according to a report by the international credit rating agency, Fitch Ratings, released at the end of 2023.

The national office vacancy rate rose from 9.5% in 2019 to 13.5% as of December last year, and it is expected to climb to 15.7% in 2024 and 16.6% in 2025.

The report highlighted that vacancy rates in metropolitan areas such as San Francisco, Houston, Dallas, Chicago, Washington DC, Los Angeles and New York are above national averages, and it was emphasized that the average office price has also fallen in most of these cities.

Secretary of Treasury expresses worry but believes situation is manageable

US Treasury Secretary Janet Yellen addressed concerns about weakness in the commercial real estate market during hearings last week in Congress regarding the annual report of the Financial Stability Oversight Council.

Yellen said that having examined the issue closely, the agency is working with banking supervisors to understand the risks.

She noted that she has concerns about the commercial real estate sector due to high interest rates and office vacancies because of changing working models post-pandemic, but believes that the situation is manageable.

Yellen mentioned that she expects stress and losses in the banking sector due to the weakness in the commercial real estate market, but said it will not become a systemic risk for the banking system.

She added that the risk of large banks is quite low, although smaller banks may be affected by these developments.

Fed Chair Powell says issue may persist for years

Fed Chairman Jerome Powell said he thinks the possibility of a banking crisis caused by commercial real estate investments is unlikely, during an interview with CBS earlier this month.

Powell noted that there will be losses due to weakness in remote working and commercial real estate. He said the Fed has looked at the balance sheet of large banks and saw that the problem is manageable, and there are some small and regional banks whose risks are concentrated in said areas.

He added that the Fed has been aware of the situation for a long time and has been working with banks to make sure that they have the resources and plans needed to overcome expected losses. He said the Fed will keep working on the problem for years, as it is a big one.

“Real estate fundamentals are in very good shape, apart from office”

Citing the soft landing in the economy, “real estate fundamentals are in very good shape, apart from office,” Richard Barkham, global chief economist at investment firm, CBRE, told Anadolu.

He noted that high interest rates and banks tightening credit facilities brought real estate transactions down to 2014 levels.

“Higher interest rates are the main factor in slowing the investment market. The office market has been hit by changes in the way people work, specifically hybrid work splitting work from the office and work from home,” he said.

“There is an increasing number of offices that cannot service loans”

Barkham highlighted that one should be careful not to generalize the risks experienced by banks and that most of the problems are in regional banks, and large banks and systemically important financial institutions are well positioned.

He underlined that the problems include large declines in real estate values, especially office values.

“The values of many loans are higher than the underlying assets they are secured on. Mostly, the buildings themselves are generating enough revenue to service the loans — but there is an increasing number of offices that cannot service loans, and there is a wave of loans coming due this year; thus, banks will have to foreclose, then dispose of assets at low prices and make charge offs to the P&L account. Some banks will fail, (but) the problem is not big enough to bring the banking system down, but it will make it difficult for real estate landing to regain momentum,” he said.

Barkham pointed out that banks also have a problem with the falling value of government bonds, noting that it could take years to solve the banking sector’s problems.

He emphasized that, theoretically, falling values could lead to a credit crunch where businesses and consumers would not have access to credit, but added that the current situation is not that bad.

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