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Soaring debt levels in the commercial real estate (CRE) sector are leading experts to raise concerns of substantial risks to economic stability in the U.S. Â
Crain’s New York Business reports that nearly $1 trillion in troubled office loans is expected to accumulate by the end of this year — and the impending financial challenges could send shockwaves throughout the U.S. economy.Â
Take the case of Herald Center, an office building on the corner of West 34th Street and Sixth Avenue in New York City. In March, the building’s appraised value is reported to have plummeted by half to $276 million. This severe devaluation occurred just three months after JEMB Realty, the building’s landlord, failed to repay a $255 million mortgage, prompting the loan to be sent to special servicing.Â
Rather than seizing the property, lenders reportedly extended the loan until January of next year — hoping the building’s financial health will recover. In theory, this approach allows debt-burdened borrowers additional time to repay maturing loans. This strategy also aims to buy time, hoping that cash flow will improve or that borrowing costs will drop with lower interest rates.Â
CBRE reported that nearly $300 billion in commercial real estate loans were extended last year alone — pushing the total due to mature this year past $900 billion. Meanwhile, banks have set aside a substantial $100 billion to cushion potential losses as they navigate this high stakes waiting game.Â
Regional banks have also increased their provisions for credit losses to help mitigate the risks associated with troubled CRE loans. However, smaller banks (with assets between $100 million and $250 billion) are reportedly more exposed to a CRE fallout. The Conference Board reports that these smaller financial institutions hold higher CRE loan concentrations, yet they maintain fewer loan loss allowances and smaller capital reserves. Smaller banks are resorting to tighter lending practices, and this helps to curb new CRE loan allowances, but it also fails to mitigate existing loan exposures.Â
It’s theorized that regulators could force banks to cleanse their balance sheets as they did in the post-savings-and-loan crisis of the early 1990s. If this does occur, Crain’s reports regulatory intervention could take place around 2025 or 2026 if inflation stabilizes and interest rates decline. However, given inflation’s unpredictable trajectory, the forecast remains dauntingly uncertain.Â
As the commercial real estate sector grapples with these unresolved debts, the future of commercial office workspaces and the broader economy remains up in the air. Banks, primarily the largest lenders to commercial real estate, are confronting the maturity of loans amidst decade-high interest rates and a significant drop in office space demand — mainly driven by the shift towards hybrid work models. Â
