Wall Street warns that the Fed's next interest rate decision could trigger a wave of commercial real estate debt defaults

Wind ·  09/19 07:49

Source: Wind

Although the Fed may keep interest rates unchanged this week, industry insiders expect that if the Fed maintains high interest rates until next year, many regional banks will face the risk of default on commercial real estate debt.

Tom Collins (Tom Collins), a senior partner in charge of regional banking and credit union business at consulting firm West Monroe, said, “What banks are most concerned about is office space.” He said that if interest rates remain high, “borrowers will face a difficult decision whether to refinance or default.”

According to Collins estimates, it is estimated that $1 trillion in commercial real estate loans will expire in 2024. Although tenants have not shied away from signing up to pay high rents, this is not the case for some properties in the financial districts of major cities.

The Federal Reserve will hold a two-day policy meeting this week. Market expectations for interest rates to remain stable are high, so there is more time to study the impact of previous interest rate hikes.

The Fed's interest rate hike in recent years has further complicated the problem for landlords, and the new debt for office buildings doesn't seem cheap anymore. After Silicon Valley Bank (Silicon Valley Bank) and Signature Bank (Signature Bank) went bankrupt in March, regional banks are also struggling to lend as deposits shift to other places with higher returns.

Loans on Wall Street are also sluggish. According to Goldman Sachs (Goldman Sachs), by the end of August this year, it had generated a “pipeline” (that is, multi-borrower) commercial mortgage-backed securities transactions worth slightly more than $10 billion, the lowest level since 2008. The coupon interest rate, which represents interest rates on mortgages, has climbed above 7%, the highest level since the beginning of this century.

Speaking about the threat of more regional bank failures, Collins said, “I don't think this is a major reshuffle.” But he does anticipate that banks that have a lot of exposure to lower quality Class B and Class C office buildings in urban areas will be distressed.

Banks can help ease impending debt by speeding up loan revisions to help borrowers keep their properties, but Collins said he also expects banks to increase loan sales, write-downs, and mergers and acquisitions.

He said, “There is no doubt that private equity and other investors will be interested in buying some of these loans and divesting them from banks' balance sheets. The obvious question is how much is the discount? I think investors will wait until things get worse before they try to get better deals.”

Another factor offsetting the risk exposure of bank office buildings is the relatively stable performance of hotels, industrial properties, and other types of real estate. However, Collins said if interest rates remain high and the economy falters, these industries may also face challenges.

The 10-year US Treasury yield is the commercial real estate industry's benchmark loan interest rate. It was close to 4.31% on Monday, hovering around a 16-year high before the Fed meeting, while the policy-sensitive 2-year Treasury yield was close to 5.06%.

According to data from Trepp, which tracks the commercial mortgage-backed securities market, the pressure on the office market increased in August. The special service interest rate for loans in bond transactions reached 7.72%, while the special service interest rate for all types of real estate loans was 6.67%. A year ago, the office loan problem rate was 3.18%.

Collins said, “If I were an investor, I'd be patient with this because I can imagine that the stock price would only fall.”

Morgan Stanley's real estate investment trust fund research team headed by Ronald Kamden (Ronald Kamden) said that for property owners, the worst seems to be yet to come. The team reiterated that by the end of 2024, prices of all commercial property types will fall by 27.4% from their highest point.

According to data from Damo, commercial real estate prices fell by 34.9% during the global financial crisis about 15 years ago, but prices rose by nearly 150% during the pandemic.


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