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Last year was bad for commercial real estate. 2024 could be worse.

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More than $900 billion in loans to support office buildings, malls, hotels, warehouses and more will mature this year — and Analysts who track commercial real estate already fear this slice of the economy could soon threaten regional banks and municipal finances.

This significant amount – about 20 percent of all commercial real estate loans in force nationwide – is facing repayment deadlines this year. But coming on the heels of a sad 2023while hundreds of billions of maturing loans have been granted short-term extensions, experts are on alert: 2024 may not go any better.

The near failure at the beginning of the month of New York Community Bancorp and its rescue thanks to $1 billion in new investments led by the former Treasury Secretary. Steven Mnuchin’s private equity firmhas reignited concerns about regional banks that began after the collapse of two companies in spring 2023. Mid-sized banks subscribe a huge volume of loans for commercial real estate, so if real estate developers and owners have difficulty repaying them, this could also trigger a chain reaction in the financial sector.

“There are going to be challenges,” said Matt Reidy, director of commercial real estate economics at Moody’s. “It might look a lot like last year.”

The office market could pose the most serious problems. For example, more than $17 billion in commercial mortgage-backed securities (CMBS) bureau loans will mature over the next 12 months, double the volume in 2023. Of these, 75% have certain characteristics that could make them difficult to refinance, depending on estimates from Moody’s. This may include properties with canceled leases, vacant buildings, or other cash flow issues.

From there, options for borrowers can range from less than ideal to bleak. In many cases, borrowers took out cheaper loans before inflation soared and interest rates skyrocketed. If businesses were to refinance now, they would likely incur higher borrowing costs on top of their existing problems. Otherwise, borrowers may try to push a deadline into the future – or find themselves in default altogether.

There is hope for some improvement this year: Moody’s data showed the office loan repayment rate in January and February was 48%, several notches above the overall performance of 35 % of 2023. Additionally, not all property types are as desperate as offices. Hotels, for example, generally perform much better after recovering from the pandemic. Industrial properties also finished last year strong.

But economists stress that it is far too early to draw firmer conclusions about whether the higher reimbursement rate will continue or whether more bad news is still to come. Based on the portfolio of loans maturing this year, Moody’s is still looking at some $10 billion in CMBS office loans that appear to be in trouble. If all of these loans were to default, the CMBS office delinquency rate could rise from the current 6.2% to more than 13%. This would pose problems for banks holding loans – especially if their portfolios are heavily weighted towards the office market – and for city centers which are already struggling to attract new tenants.

Although it will take a few more months to get the full picture, the first signals should appear soon, said Lonnie Hendry, product manager at analytics company Trepp.

“Are they getting any expansions or changes? Are they able to refinance? Hendry said. “If that doesn’t happen and they persist, it could bode poorly for what’s left for 2024.”

Zooming out, the country has made a remarkable comeback since the pandemic upended every corner of the economy and daily life. Growth maintains a solid pace, the job market remains tight, and the Federal Reserve’s aggressive attempts to raise interest rates and control inflation have not caused the recession that seemed all but guaranteed.

But the dangers associated with commercial real estate – particularly offices – persist. Buildings nationwide remain empty as businesses rethink how much physical space they need, make do with smaller spaces or move away altogether. Restaurants in major city centers are still closing their doors, lamenting quiet weekdays and empty weekends. Some economists fear a sort of “catastrophic loop” it starts with empty buildings here and there, then turns into something scarier for city budgets that rely heavily on property taxes and wages.

Ultimately, the risks will come from individual banks and borrowers themselves, many of whom are resorting to a practice known as “extend and pretend” to get through these difficult years.

Popularized after the Great Recession, the first step is to extend the maturity date of a loan, keeping the payments and interest rate on the same schedule rather than refinancing or paying it off. Then the borrower and the bank “pretend” that the value of the loan is still intact – and has not decreased. This means banks don’t have to write down loans that are no longer worth what they were when they were first made.

The workaround gained traction after the Great Recession, when the Fed lowered interest rates and kept them low to stimulate the economy. At the time, it was meant that struggling borrowers could refinance their loans and get rates that were often lower than what they had previously paid.

But over the past two years, rates have moved in the opposite direction. The Fed’s drive to raise borrowing costs and catch up with soaring inflation ultimately brought rates to their highest level in 23 years. The central bank is should reduce rates several times this year, but these measures will not significantly reduce borrowing costs. And ultimately, this could cause lenders and borrowers to face the harsh reality: They cannot “pretend” to own their properties and the loans no longer lost value.

Hendry said the strategy of stretching out and pretending might be the wrong medicine at the moment.

“There’s a revisionist history about why it worked, so people are looking at it now,” Hendry said. “If enough lenders extend loans and the market doesn’t improve, it could have a truly catastrophic impact.”

A sign of difficulty is that some buildings are already sell at heavy losses. Trepp data shows that commercial real estate prices fell last year by 5.3 percent. In downtown Washington, a building that cost $100 million in 2018 sold in December for just $36 million. Outside of Boston, an office that was worth $43 million six years ago just sold for $6 million.

Generally, This discouraging picture is prompting policymakers and economists to closely monitor small and mid-sized banks – lenders with less than $250 billion in assets – which hold about 80% of the overall stock of commercial mortgage loans, according to estimates from Goldman Sachs. That scrutiny intensified last year, after the sudden failure of two regional banks — Silicon Valley Bank and Signature Bank — but not primarily because of commercial real estate loans. The collapses caused brief but considerable panic throughout the financial system and encouraged an emergency response from the government.

NYCB ended up buying out a large portion of Signature’s assets afterward, which added to some pre-existing issues. Much of the bank was concentrated in rent-controlled apartment complexes as well as offices — a combination that made cash flow even tighter when people were still working from home and in residence. the owners too can’t follow market rents.

Still, regulatory experts say they are confident that commercial real estate is not on the verge of imploding or endangering the entire financial system. They argue that the risk is well understood and that banks are aware of the loans on their books. Even if 2024 brings its share of flaws, the consequences could look more like rising waters than a sudden tidal wave.

For its part, the Fed views the potential for significant losses in commercial real estate as a risk factor. risk to financial stability. The central bank is also using a marked decline in commercial property prices as part of its regular test of the banking system’s resilience to major shocks and stressors.

“We have identified banks that have high concentrations in commercial real estate, particularly office and retail, and others that have taken a big hit,” said Fed Chairman Jerome H. Powell , to lawmakers earlier this month. “This is something we will be working on for years to come, I’m sure. There will be bank failures, but not the big banks.”

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