With several banks collapsing in the U.S., many investors are cautious regarding commercial real estate. Whether you are currently invested in CRE or considering investing, it is vital that you carefully look at the market to steer you in the right direction. Today, most investors wonder if the CRE market is at risk and want to find the best way to navigate through all the uncertainty.
There are various commercial real estate market sectors, and not all are at risk. Empty offices and high-interest rates are the biggest risks in the market, and diversifying, refinancing, and strengthening your credit performance will help you navigate the uncertainty.
The commercial real estate market is uncertain due to high-interest rates, collapsing banks, and the struggle to fill empty offices. Remote working is the main cause of why CRE properties are struggling to find tenants, causing them to default on their loans. If you are investing in CRE or considering investing, this article will help you navigate the uncertainty.
Is Commercial Real Estate In Trouble?
Most commercial real estate is mortgaged, and several banks in the U.S. collapsed after the markets had a rapid decline in global bank stock prices. Banks like Signature NY, Silvergate, Credit Suisse, and Silicon Valley Bank (SVB) closed, sparking a major crisis in the banking sector, including CRE sectors.
CRE investors are also struggling to fill empty office space after the COVID-19 epidemic and the sudden rise in interest rates. Many companies had to relocate their business operations to their homes, while others did not survive the sudden market collapse. Various factors left investors struggling to refill empty offices, causing a devastating decline in revenue.
Here are some of the reasons why CRE markets are in trouble:
- Growing Vacancy Rates: Significant markets like Silicon Valley and Manhattan suffer from record-high vacancies in CRE properties. Finding new tenants after old leases expire indicates a challenge as it places downward pressure on property values and rental prices.
- Refinancing struggle: CRE markets are facing a major refinancing challenge soon. Several commercial loans are up for refinancing, and with the spike in vacancies and higher interest rates, investors and CRE owners may struggle to secure reasonable terms. It may also cause financial instability in the market and lead to defaults.
The potential impact struggling CRE’s have on the economy:
- Credit Squeeze: A probable credit squeeze in CRE markets could generate broader implications for the whole economy, like a reduction in investments, a slowdown in lending, and negative economic growth.
- Tax Base Affects: The high volume of vacant offices within CRE properties can harm the municipality’s tax base. With low tax revenues and diminishing property values, local governments will face economic challenges to fund essential services.
Will Commercial Real Estate Crash?
A total commercial real estate crash is highly unlikely, but struggling businesses and the volume of empty buildings cause concern in some areas. The commercial real estate sector is straining, with fewer investors finding favorable mortgages and development loans.
Some areas show increased CRE buyers, especially where the demand for office space has increased due to businesses relocating to favorable areas with a limited supply. Many commercial real estates are up for refinancing in the coming years, which is of great concern.
Here are some of the concerns CRE investors must consider in 2023:
Banking Unrest Is Coming
According to Lisa Shalett, the Chief Investment Officer of Morgan Stanley, CRE lending rates are of great concern in the coming years. New lending rates for commercial real estate are expected to increase even if interest rates remain steady, which will impact several banks. Currently, 190 banks face similar challenges to Silicon Valley Bank, and increasing lending rates will impact them all.
Many commercial real estate loans go through medium and small banks, and higher lending rates will influence investors, leaving the banks vulnerable.
Vacant Offices And Declining Demand
The collapse of Silicon Valley Bank had a huge influence on the market, but there were other factors like high maintenance costs and empty offices already affecting the CRE sector. Commercial real estate investors rely on tenants to fill the office space to generate revenue, and with the increase of businesses working remotely, many buildings are left empty.
According to analysts at Morgan Stanley, commercial real estate prices are expected to decline up to 40%, last seen during the 2008 financial crisis. All these factors impact investors’ decisions to buy CRE, and it causes banks to increase their loan approval requirements to prevent financial loss.
Components Of Vulnerability And Resilience
The location of commercial real estate impacts its success, but the type of CRE also impacts its vulnerability and resilience. The CRE sector includes several types of assets: office buildings, apartments, shopping centers, data centers, hotels, and many others.
Not all CRE investments are vulnerable; for example, e-commerce supporting industrial buildings and data centers has shown some resilience. On the other hand, office space shows concerning market shifts with significant challenges.
Investigating Office-To-Residence Conversions
Although the demand for office space is in decline, the residential demand is skyrocketing, which provides an ideal opportunity for investors. Many commercial properties are facing foreclosure with all the empty offices, and many investors are considering changing them into residential properties.
State and local officials are fighting to keep their cities vibrant with the mass exodus of businesses. They collaborate with private capital regulators, legislators, and investors to exploit the housing opportunity to avoid cities collapsing.
Managing The Commercial Real Estate Market Crisis
Rising lending rates and many empty offices have prompted innovative ideas to protect investors and help them manage the commercial real estate market crisis.
- Diversifying Commercial Real Estate: Offices in the CRE sector face major challenges while retail, industrial, and hotels perform reasonably well. Diversifying your CRE assets can safeguard against potential risks, and a strong segment can counterbalance those struggling.
- Managing Refinancing: Many investors face the refinancing cliff, but many CRE debt gets refinanced without major issues. Strict lending standards by banks are still in place, but most CRE’s generate sufficient income to cover their debt to meet these standards. Well-managed CRE’s and many able to refinance indicate some stability in the industry.
- Strengthening Credit Performance: Banks have shown extraordinary credit performance in lending to CRE, with low default rates and little loss. It also indicates that lenders have successfully managed risk and exercised caution, restraint, and resilience.
Conclusion
The General commercial real estate market has shown a lot of resilience over the past few years, and only the office rental sector has taken the largest knock. CRE sectors like retail, industrial, and hotels are still good investment opportunities, and most banks still provide loans at reasonable lending rates. Investors must consider all aspects and proceed with caution before investing in CRE.