It’s not an understatement to say that the commercial real estate market has been devastated by the banking sector’s decision to tighten lending regulations earlier this year. New commercial mortgage loan originations are down nearly 50% year-over-year over the third quarter, and down 7% compared to Q2 2023. At the same time, delinquent commercial real estate loans are higher than they have been in the last ten years and will likely become increasingly commonplace as an eye-popping $1.5 trillion in commercial mortgage loans becomes due in the next few years. In times past, banks may have allowed borrowers to refinance such loans easily and at a low interest rate; however, market conditions no longer allow for such arrangements. If banks are willing to refinance such loans at all. The current average interest rate for most commercial mortgages is close to 7%, a far cry from the 2021 average of 4% – 5%.
Some forms of commercial real estate have been hit harder by tightened lending regulations than others. Loans on healthcare properties are down by 76%, which is not entirely surprising considering the fact that healthcare facilities are struggling to turn a profit post-COVID. Loans on retail properties are down 20% from last quarter while multifamily property loans crashed by 16% during this same time period and are down 54% year-on-year. In the case of retail properties, it would appear that the continued growth of online shopping is taking a toll on brick-and-mortar outlets. Multifamily properties, which have always been a profitable investment, are not seeing a decrease in demand. On the contrary, the fact that many aspiring homeowners are putting their home purchase plans on the back burner until interest rates go down is sure to contribute to a rise in demand for rental housing. However, banks have always considered this property to be a high-risk investment, and they have little appetite for taking risks in the current environment.
On the other hand, loans on industrial properties are up 36% this quarter. Office loans are up 4% from last quarter while commercial loans for hotels were up 2%. The rise in office loans may come as a surprise, as the office sector has struggled to attract buyers and tenants in a world where many companies are making the switch to virtual or hybrid work arrangements. However, the fact that commercial office loan originations are still almost 50% lower than they were last year shows that office investments aren’t making a comeback. Loans on industrial properties are down 35% from the same time last year, while loans on hotel properties are down 52% from Q3 2022.
Experts are warning that the sector is in trouble and there is no quick, easy solution. Bill Moreland from BankRegData points out that the current market situation isn’t a hiccup caused by COVID. He predicts that loan delinquencies will keep rising, and property values will continue coming down. Jamie Woodwell, the head of the Mortgage Bankers Association’s commercial real estate research department, explains that the CRE market won’t stabilize while interest rates remain high and volatile and there is uncertainty about property values. Unfortunately, banks are not in a position to loosen stringent loan regulations as they struggle with rising bond values that put a strain on their balance sheets. As the banking sector saw in March 2023, it doesn’t take much to start a bank run and the results can be devastating unless the bank has enough cash on hand to allow for multiple withdrawals without having to sell bonds at a loss.
The pressure on the CRE market isn’t going to let up for the foreseeable future. Banks are being squeezed by high interest rates on one hand and a rise in delinquent commercial real estate loans on the other hand. Thus, even investors who have a good track record of paying loans back on time will likely face continued struggles to secure financing. However, this doesn’t mean that all CRE investment possibilities should be discounted. As commercial real estate continues to fall in value, investors may be able to find exceptional properties at rock-bottom prices. With thorough research, access to capital, and a willingness to wait for a return on the investment, investors could not just weather the current storm but come through better off in the long run.
Have questions?
Peak Commercial is committed to providing you with the latest and most up-to-date information affecting you and your commercial real estate investment portfolio. Contact one of our expert commercial real estate brokers or team members today to learn more.
info@peakcommercial.com
(818) 836-6717