LAS VEGAS — A sharp downturn in commercial real estate performance could have a big impact on the banking sector, but not big enough to destabilize the financial system, according to analysis from one of the top real estate economists in the country.
More than 300 banks have enough commercial real estate loans on their books to see their Tier 1 capital wiped out under a worst-case scenario, Richard Barkham, chief economist and head of research at CBRE, said this week during a conference hosted by the National Association of Real Estate Editors.
Barkham said the real estate advisory firm analyzed Federal Deposit Insurance Corp. data on the balance sheets of 4,800 insured banks to identify the banking sector's total exposure to commercial real estate. It then applied a hypothetical stress scenario in which property values and net operating incomes fell enough to result in a total loss.
Under this extreme — and unlikely — scenario, Barkham said 311 banks would fail, with the vast majority being community banks, along with about 20 regional banks and one large bank. He did not identify which banks are most exposed to this risk. Barkham said the assets of the failed banks in the scenario totaled about $600 billion, roughly three times the size of Silicon Valley Bank, which failed in March.
"This is going to be a problem for bank earnings. Banks are going to have to write down the loans, write down their earnings, but there isn't enough here to bring down the banking system," Barkham said. "It's irresponsible, I think, to suggest that it will."
Barkham argued that there is little reason to believe that commercial real estate could drag down the banking sector in the way the residential mortgage market did in 2008. He noted that the residential real estate sector totals about $43 trillion, while all of commercial real estate accounts for just $21 trillion, with office properties — the most embattled property type — accounting for 20% of that total.
"In terms of the scale of the value loss feeding through to loan loss, it's entirely different from what we saw during the great financial crisis," he said. "I'm not saying it isn't a problem. I'm just saying don't concatenate the great financial crisis with the current issue in commercial real estate."
As employees continue to work from home and companies shed unused office space, office properties have seen their revenues and valuations fall in recent years. These issues are compounded by the fact that many of these properties are financed with floating-rate debt that has become increasingly expensive to service thanks to a slew of rate increases by the Federal Reserve last year.
Regulators and analysts have flagged trouble in the commercial property sector as an area of heightened risk for the months ahead.
The Fed's most recent financial stability report noted commercial real estate as one of the top concerns among the broker-dealers, investment funds, research and advisory organizations and academics it surveyed.
Federal Reserve Bank of New York President John Williams described these headwinds for the office sector as a "real issue" for banks and something supervisors are "paying very close attention to."
Another issue facing the commercial real estate sector is an impending wave of maturities that will force property owners to refinance their assets. The data analytics firm Trepp estimates that a record $270 billion of bank-held commercial mortgages will mature this year alone.
Annie Rice, a capital markets executive with the advisory firm JLL, said banks are taking steps to ease the blow of this looming debt maturation, including making it easier for borrowers to get loan extensions and softening the terms of recapitalization agreements.
"Banks are working closely with borrowers because they do not want to take assets," Rice said. "They want to make sure that they're positioned where they can really come out of this unscathed."
Jim Costello, head of real estate economics at the analytics firm MSCI, said the next two years will be especially precarious for the office sector as it deals with expiring loans. But, he added, direct mortgage lending is only part of the equation.
Costello, who also spoke during the NAREE conference, noted that banks have indirect exposure to commercial real estate via lines of credit and other types of financing they extend to nonbank lenders, such as debt funds, which specialize in higher-risk construction and bridge loans.
"To me, that's a transmission mechanism that could impact the banks and impact the financial system," he said. "People are worried about that."
Costello said this type of nonbank exposure is particularly vexing for regulators because they have little insight into the specifics of this activity. The Paperwork Reduction Act allows banks to categorize this type of lending under the umbrella term "loans to other financial institutions" when reporting to their regulators.
"Regulators are worried about debt funds because they don't see what they're doing," he said. "They have no oversight on them."
