A recent report commissioned for the National Bureau of Economic Research reveals that falling commercial-property values are escalating solvency risks for numerous small and regional U.S. banks. Approximately 14% of all commercial real estate loans, with a staggering 44% related to office buildings, are now seemingly in “negative equity,” where the debt surpasses the current property value. This precarious situation heightens the likelihood of borrowers defaulting as their financial stakes are eroded.
According to analysts, this distress could lead to the inclusion of anywhere from dozens to over 300 predominantly smaller regional banks in the category of institutions facing solvency risks.
As of the third quarter’s conclusion, U.S. banks collectively held about $2.7 trillion in commercial real estate debt, as outlined in the report authored by analysts from the University of Southern California, Northwestern University, Columbia University, and Stanford University.
Commercial-property values have witnessed a 22% decline since the first quarter of 2022, coinciding with the Federal Reserve’s commencement of interest rate hikes to counter inflation. Office prices have notably plummeted by 35%, reflecting weakened demand for office space amid the widespread adoption of remote work.
The impact of interest rate hikes is evident in recent bank failures, such as Silicon Valley Bank and Signature Bank, along with the distressed sale of First Republic Bank. Clients withdrawing deposits, coupled with banks being burdened with illiquid, low-yielding loans, contributed to these challenges.
The report indicates that a 10% default rate on commercial real estate could result in approximately $80 billion in additional bank losses, escalating to an estimated $160 billion if the default rate reaches 20%. In the global financial crisis 15 years ago, delinquency rates on commercial-property loans peaked at about 9%, with charge-offs reaching 3.3%, according to Federal Reserve data.
The authors emphasize that these findings carry significant implications for financial regulation, risk supervision, and the transmission of monetary policy.
