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One of the steepest price declines in commercial property in at least a half century heightens risks to investors and lenders. The IMF wants regulators to be vigilant to these growing risks

Economy / opinion
One of the steepest price declines in commercial property in at least a half century heightens risks to investors and lenders. The IMF wants regulators to be vigilant to these growing risks
Internal office

By Andrea DeghiFabio Natalucci, and Mahvash S. Qureshi

The commercial real estate sector has been under intense pressure globally as interest rates have risen over the past couple of years. In the United States, with the largest commercial property market in the world, prices have tumbled by -11 percent since the Federal Reserve started raising interest rates in March 2022, erasing the gains of the preceding two years.

Higher borrowing costs tend to dampen commercial property prices directly by making investments in the sector more expensive, but also indirectly by slowing economic activity and reducing the demand for such properties. Nevertheless, the sharp decline in prices during the current US monetary policy tightening cycle is striking. As the Chart of the Week shows, contrary to the current policy cycle, commercial property prices remained generally stable or saw milder losses during past Fed rate hikes. Some of the earlier rate hikes, though, such as in 2004-06, were subsequently followed by a recession during which commercial property prices recorded notable declines as demand fell.

Part of this divergence in price behavior between the recent and past monetary policy tightening cycles may be attributed to the steep pace of monetary policy tightening this time around, a factor that has contributed to the sharp increase in mortgage rates and commercial mortgage-backed securities spreads. It has also notably slowed private equity fundraising—an important source of financing for the sector in recent years, as noted in our recent Global Financial Stability Report.

Notwithstanding recent declines in US Treasury yields, higher financing costs since the beginning of the tightening cycle and tumbling property prices have resulted in rising losses on commercial real estate loans. Stricter lending standards by US banks have further restricted funding availability. For example, about two-thirds of US banks recently reported a tightening in lending standards for commercial construction and land development loans, up from less than 5 percent early last year.

The effects of tightening financial conditions on commercial property prices over the past two years have been compounded by trends catalyzed by the pandemic, such as teleworking and e-commerce, that have led to a drastically lower demand for office and retail buildings and pushed vacancy rates higher. Indeed, prices have slumped in these segments, and delinquency rates on loans backed by these properties have risen in this cycle of monetary policy tightening.

These challenges are particularly daunting as high volumes of refinancing are coming due. According to the Mortgage Bankers Association, an estimated US$1.2 trillion of commercial real estate debt in the United States is maturing in the next two years. Around 25 percent of that is loans to the office and retail segments, most of which is held by banks and commercial mortgage-backed securities.

Prospects for the sector remain challenging, even as Fed officials signal interest rate cuts this year and investors grow more optimistic about a soft landing for the economy. Financial intermediaries and investors with a significant exposure to commercial real estate face heightened asset quality risks. Smaller and regional US banks are particularly vulnerable as they are almost five times more exposed to the sector than larger banks. The risks posed by the commercial property sector are also relevant for other regions, for example, in Europe, as many of the same factors are at play as in the US.

Financial supervisors must continue to be vigilant. Rising delinquencies and defaults in the sector could restrict lending and trigger a vicious cycle of tighter funding conditions, falling commercial property prices, and losses for financial intermediaries with adverse spillovers to the rest of the economy. Ongoing monitoring and management of risks related to the sector will be important to mitigate potential risks to macro-financial stability.

This article was originally posted here.

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This has been coming for 4 years now. The elephant in the investment room is [and always has been] CRE which will eventually put pressure on banks balance sheets, as the article explains. It's the same here, perhaps to a lessor degree, with offices in particular high risk ventures from the post-covid WFH addition.

Asset cycle downturns come around every decade or so & IMO is good for the long term nature of investing. The cycle provides buy-in opportunities as well as potential downside scenarios for more established investors. Timing is crucial. The  write-downs are hard to do but a necessary reality. I see 2024 as the year reality finally catches up with the over-indebted investor, especially those with CRE as its major exposure.

We've written down ours recently, & this after not putting them up last year, but I know that not everyone is comfortable doing that, especially those who are carrying large commitments. So, there's a lot of pain still to come, which will also bring with it opportunities for some.


Lol. Can we see another real estate crisis coming? Why yes we can. Should we call it GFC 2.0?

On a more serious note, do you think we'll hear the gurus say, "nobody could have seen that coming"? Probably won't inspire another GFC as I can see governments responding with 'rescue packages'. i.e. socialising the loss once again.

I wonder how badly Trump will get hit? (lol - couldn't happen to a nicer guy. no wonder he wants to be president again!)


Nah, it's still GFC 1.0

It never ended, it was conveniently covered up by several iterations of QE. There is so much debt in the banking sector, the only way to avoid the crises surfacing is to increase the value of future cashflows. Does that mean pumping money into the real economy? No, it means lower and lower interest rates, lower and lower yields. To the point where a few hundred dollars rent a week can service a million dollar townhouse. Looking at property, what is a consistent yield across the board right now? Negative 3-5%? For RE to continue to go up in real terms, somebody must always be willing to take a lower yield at a higher price and in lieu of a lower rate you'd be desperate to find a greater fool. For young people, they are beating the market by 3-5% just by renting. Trouble is, the rental market is over-priced as well.

If you're looking for CG in RE this year, consider a potential fall in interest rates already priced in to the current market. The market is betting big time on those rates coming down in the near future. All asset classes are. I'd suggest we are in a market priced at about 1.5-2% lower rates than available today. So for the market to move up from there, we'd be betting we return to war time spending, $60b+ in RBNZ asset purchases, <2% OCR, billions of dollars of Govt. spending. That's an interesting bet.


You're saying a fall in i-rates is baked into current prices? Maybe.

But the b.s. from the retail banks gets far more coverage than we do so I'm not so sure.


Has anyone got any comments on what is going on in the commercial real estate market in NZ?

Read a report that some unlisted property investment funds are asking their investors for funds (i.e capital raising) to reduce leverage in the portfolio as commercial property valuations are falling. 

In that same report, there was an investor in the fund who was unable to sell their units, and the investment manager was also selling their units.…


This is the 5000lb gorilla, but I’m sure NuZullin will be just fine….

We’re immune from major credit events. NZ real estate agents told me so….


Raising money to pay down debt by unlisted commercial property funds does not work as many such funds are finding out to their cost.

in order to raise these funds they have to offer incentives and at least a return equal to bank deposits. Hence they may raise some money to pay down debt but it will not help the situation as the interest they were paying the bank is now being used to paying new investors. Who, in their right mind, would invest into a fund for no return?
Some of these funds are making things even worse by offering new shares at heavily discounted prices which makes a mockery of their oft touted capital gains. 
On the grey market large blocks of such shares or units are on offer at knock down prices, with no takers.

The heart of the problem is that borrowing more that 30% against a commercial property is a guarantee that difficulties will rise sooner or later as interests rates wax and wane.

Private investors in commercial property are not so easily bothered  when interest rates go high because they rarely if ever are obliged to pay dividends so can sweat it out, which is a pain but that’s all. 

At this moment there are a large number of private investment funds on the brink of collapse through past greed and mind blowing stupid investments, existing to expand mainly to pay higher fees to the managers.

It’s only the banks holding hands that is preventing a rout in this area, but time is not on their side. Banks don’t want to become managers of distressed commercial property..a nightmare they don’t need as managing commercial property is a skilled job, a skill only a few people really have.