Banks' aggressive efforts to scale back their office loan portfolios are intersecting with declining vacancy rates and lower interest expenses — a trifecta of bullish developments that could ease nagging commercial real estate pains in 2025.
Office CRE is under pressure after remote work trends and population losses from urban cores spurred
Additionally, with empty spaces, the valuations of many office buildings fell, increasing the level of banks' loans relative to what the properties were worth. This made some loans more vulnerable to default. Borrowers are more likely to walk away from loans they are struggling to make payments on or that they have diminishing hope of paying off by selling properties.
However, the Fed successfully lowered inflation over the past couple years and, in September, cut its benchmark rate by 50 basis points. It announced a 25-basis-point reduction this month and has signaled further cuts were in the cards. Reduced credit costs could soothe concerns about struggling borrowers.
"Areas such as office CRE will likely
At the same time, the U.S. office sector vacancy rate for the third quarter, including subleases, held even at 20.1%, according to Moody's. This followed three consecutive record-breaking quarters. The vacancy rate had steadily moved up from 16.8% in the fourth quarter of 2019, just before the coronavirus pandemic arrived in the U.S. and galvanized widespread work-from-home policies, the firm said.
While remote work trends endure and vacancy rates could remain elevated through 2025, more companies have brought workers back to offices via hybrid programs. In other cases, office buildings were refashioned for other uses.
"Downsizing activity is steadily normalizing as tenants become more comfortable with their existing office footprints," Jones Lang LaSalle analyst Jacob Rowden said. "At the same time, new supply has fallen dramatically, and a record volume of inventory is being removed for conversion and redevelopment, leading to a tightening office market nationally for the first time since 2019."
At the start of 2024, the U.S. office market accounted for nearly $3 trillion of the $20 trillion commercial real estate market, according to Jones Lang LaSalle.
The shift on interest rates and leveling off of vacancy levels came as banks
Still, criticized loans at publicly traded U.S. banks totaled $264 billion at the mid-point of 2024, S&P data show. That was up from $240 billion at the start of the year, with office CRE a key driver of the increase. Issues continued in the third quarter. For example, First Interstate BancSystem in Billings, Montana, said its net charge-offs doubled from the prior quarter to 60 basis points of average loans due largely to two metropolitan office loans. But the $29.6 billion-asset bank said it would avoid similar loans moving forward and
While third-quarter data was still trickling in, other bankers anecdotally also said office loans remained a source of some weakness, but conditions were no longer worsening. During recent interviews and earnings calls, bank executives said they remained cautious, particularly in downtown areas of major cities that are reliant on the flow of workers in and out of office towers. Yet they were optimistic about improvement in the year ahead.
OceanFirst Financial Corp. in Red Bank, New Jersey, posted an increase in charge-offs at one point last year due to its participation in a
"The concern that there would be serious broad-based issues has not played out in the data," Maher said. "We may be at a turning point…I think you saw and heard that across the earnings season."
The Providence, Rhode Island-based Citizens Financial Group continued to work through
"It is definitely turning and feels better," Don McCree, head of commercial banking at Citizens, said in an interview. Lingering challenges "are easily manageable," he added. "We are seeing credit stats turn more positive already, which is encouraging."
