Empty Offices Increase Bank Lending Risk for CRE
Banks lending to commercial real estate are being squeezed by the ongoing vacancy of office and business spaces post-COVID-19.
Recent reports reveal a rise in delinquencies on commercial real estate loan payments, compounding a series of financial sector challenges, such as bank failures, inflation, and climbing interest rates.
This issue is spotlighted in relation to previous bank failures and compared to the last financial crisis. Banks are tasked with risk evaluation and management.
Challenges in loan repayments increase a bank’s credit risk — the possibility of borrowers defaulting.
Pandemic/Remote Work Induced
The pandemic-induced remote work trend has not only impacted occupancy rates in office buildings and stores but also triggered a fall in property values across the U.S.
Higher vacancy rates imply less demand for building space, hence a reduction in its worth.
This has consequences for building owners seeking to renegotiate or refinance loan terms due to financial distress — they are met with stricter terms and increased interest rates.
Higher loan payments and continued high vacancy rates may pose difficulties in loan repayments for property owners, potentially leading to a surge in delinquencies and defaults.
If risks are not appropriately managed, it can spell disaster for banks, especially when coupled with rising interest rates and quick growth.
Case in point: the failures of Silicon Valley Bank and Signature Bank. During the 2007-2009 financial crisis, 414 insured U.S. banks failed.
An examination found that failures of small and medium-sized banks were primarily tied to high concentrations of commercial real estate loans.
These banks often adopted aggressive growth strategies in commercial real estate lending and displayed weak credit risk-management practices.
A similar pattern of aggressive growth strategies and weak risk-management practices was observed in the March failures of Silicon Valley Bank and Signature Bank.
Recent reports indicate that banks’ exposure to commercial real estate lending is once again on the rise. By the end of Q1 2023, a total of 576 U.S. banks were found to have surpassed regulatory guidance on commercial real estate loan concentrations — a 30% rise compared to the same period in 2022.
Banking Regulation
Regulators publicly stated that banks have remained robust and resilient following the recent bank failures.
However, the ongoing pandemic recovery phase and the option for some employees to continue remote work or adopt hybrid work models may continue to impact the demand for office space and the performance of commercial real estate loans.
This creates ongoing uncertainty about the associated risks. The situation will continue to be monitored closely, with a focus on commercial real estate lending and the regulatory oversight of the banking sector.
