Report: Commercial Real Estate Exposures Could Lead to Bank Failures in Pockets of the U.S.

A plunge in demand surrounding office spaces may negatively influence the commercial market, resulting in bank failures in pockets of the nation, an assessment made recently by Ken H. Johnson, a real estate economist in FAU’s College of Business, and Rebel A. Cole, a chaired professor of finance in FAU’s College of Business, in a recent release by the university. 

The combination of rising interest rates, high office vacancies—thanks to remote work—and lowering returns on investments, has revealed weaknesses in the banking system, the experts said, as billions of dollars in commercial real estate loans are also approaching repayment deadlines.

“The demand for office space has fundamentally shifted downward. During the pandemic, people began to work from home instead of heading into the office. Now, four years later, that is still the case,” said Cole. “It’s a problem for the banking system as there are a lot of banks that have extensive exposure to risk.”

Key stats from the release:

Regarding banks of any size, 1,522 out of 4,641 have total commercial real estate exposure greater than 300%, according to Cole’s recent analysis of available bank regulatory data in Q4 of 2023. Further: 

  • 732 have exposures greater than 400% 
  • 320 have exposures greater than 500%
  • 113 have exposures greater than 600%

Both experts conclude that various banks may potentially fail, likely in areas with remote work dominating, leaving large sums of offices vacant—in the Northeast and California, for example.

“Inflation hasn’t cooled as fast as the Fed has hoped, which should lead to a more hawkish Fed,” said Johnson. “A less favorable rate environment combined with declining rents is affecting the value of commercial office space, worrying banks and bank regulators.”    

Johnson’s take on potential closures is that they should be minimal, and won’t likely cause stress on the banking system—banks will choose to work on deals with investors instead.

He added that states such as Colorado, Florida and Utah are less likely to face bank failures, with a higher demand for office space. These are hot-spots for many new companies looking to consistently meet face-to-face.

“There is a lot of investment capital looking to step in and buy shares, if you will, of these buildings due to the large amount of perceived equity. Banks have opportunities for deals to be worked out short of the owner simply turning over the keys to the building,” Johnson said. “The likelihood of a massive financial crisis similar to 16 years ago is very small.”  

Cole couldn’t directly indicate how large the impact could be, but commented that another substantial bank failure within a year could cause panic in the system.

“This is a very serious development that won’t go away,” Cole said. “Higher mortgage rates affect all properties, including both commercial and residential mortgages. There’s growing concern that, with higher interest payments, these properties will no longer be cash flow positive. If owners walk away from these buildings, it creates a comparable sale at a huge discount, leading appraisers to mark down the value of other properties with positive cash flows.”

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