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A Summary of the Impending Commercial Real Estate Crisis for Businesses

By Adam Esquivel, Smith Business Law Fellow J.D. Candidate, Class of 2025

Earlier this year, Jerome Powell, Chair of the Federal Reserve, cautioned the Senate Banking Committee about the upcoming failure of small banks distributing commercial realty (CRE) loans. [1] As of June 2024, outstanding CRE loans in America quantity to almost $3 trillion, [2] and about $1 trillion will end up being due and payable within the next 2 years. [3] In addition, CRE loan delinquency rates have actually increased substantially given that 2023. [4] Roughly two-thirds of the currently impressive CRE debt is held by little banks, [5] so business owners must watch out for the growing capacity for a terrible market crash in the future.

As lockdowns, constraints and panic over COVID-19 slowly went away in America near completion of 2020, the CRE market experienced a surge in demand. [6] Businesses taken advantage of low interest rates and gotten residential or commercial properties at a higher volume than the pre-recession realty market in 2006. [7] In many ways, businesses committed to the concept of a post-pandemic "migration" of employees from their remote positions back to the office. [8]
However, contrary to the hopes of numerous organization owners, workers have not re-entered the office. In truth, workplace vacancy rates reached a record high of 13.2% in 2023. [9] Additionally, substantial post-pandemic development in the e-commerce market has American shopping malls reaching a record-high job rate of 8.8%. [10] This decrease in demand has actually resulted in a reduction in CRE residential or commercial property values, [11] thus negatively affecting lending institutions' positions via increased loan-to-value ratios (LTV). Yet, while bigger banks have already started reporting CRE loan losses, small banks have not followed suit. [12]
Because many CRE loans are structured in a way that needs interest-only payments, it is not for entrepreneur to refinance or extend their loan maturity date to get a more beneficial rate of interest before the full principal payment ends up being due. [13] Given the state of the present CRE market, nevertheless, large banks-which undergo more stringent regulations-are most likely reluctant to engage in this practice. And due to the fact that the common CRE lease term ranges from about 3 to 5 years, [14] numerous commercial landlords are battling against the clock to avoid delinquency or even defaulting under their loan terms. [15]
The existing absence of reporting losses by little banks is not an indicator that they are not at threat. [16] Rather, these institutions are most likely extending CRE loan maturities with their fingers crossed, hoping that residential or commercial property values in the industrial sector recover in a timely way. [17] This is an unsafe game because it brings the danger of producing inadequate capital for small banks-an effect that could result in the destabilization of the U.S. banking system as a whole. [18]
Company owner borrowing CRE loans need to act rapidly to increase their liquidity on the occasion that they are not able to refinance or extend their loan maturity date and are forced to begin paying the principal for a residential or commercial property that does not produce sufficient returns. This needs company owner to work with their banks to seek a beneficial option for both parties in the event of a crisis, and if possible, diversify their properties to produce a monetary buffer.

Counsel for at-risk organizations need to carefully review the arrangements of all loan contracts, mortgages, and other paperwork overloading subject residential or commercial properties and keep management notified regarding any terms developing raised dangers for the organization as stated therein.

While business owners should not stress, it is necessary that they start taking preventative measures now. The survivability of their organizations may effectively depend on it.

Sources:

[1] Tobias Burns, Wall Street braces for business property time bomb, The Hill: Business (Mar. 14, 2024) https://thehill.com/business/4526847-wall-street-braces-for-commercial-real-estate-timebomb/amp/.

[2] NAR, industrial property market insights report 4 (2024 ).

[3] Dana M. Peterson, U.S. Commercial Real Estate Is Heading Toward a Crisis, Harv. Bus. Rev.: Corporate Finance (July 23, 2024) https://hbr.org/2024/07/u-s-commercial-real-estate-is-headed-toward-a-crisis.

[4] Id. (CRE loan delinquency rates were.77% in 2023 and 1.18% in 2024).

[5] Id.

[6] Milton Ezrati, Covid's Long Shadow Still Spreads Over Commercial Realty, Forbes: Leadership Strategy (Mar. 17, 2023) https://www.forbes.com/sites/miltonezrati/2023/03/17/covids-long-shadow-still-spreads-over-commercial-real-estate/.

[7] Scholastica Cororaton, Commercial Weekly: Commercial Real Estate Outperforms Expectations in 2021 and is Poised to Strengthen in 2022, NAR: Economist's Outlook (Dec. 23, 2021) https://www.nar.realtor/blogs/economists-outlook/commercial-weekly-commercial-real-estate-outperforms-expectations-in-2021-and-is-poised-to.

[8] Id. (describing the "huge re-entry" as depending on the effectiveness of the COVID-19 vaccine versus various versions of the virus).

[9] Fin. stability oversight Council, Annual Report (2023 ).

[10] NAR, supra note 2, at 7.

[11] Peterson, supra note 3.

[12] Id.

[13] Konrad Putzier, Interest-Only Loans Helped Commercial Residential Or Commercial Property Boom. Now They're Coming Due., WSJ: Residential Or Commercial Property Report (June 6, 2023) https://www.wsj.com/articles/interest-only-loans-helped-commercial-property-boom-now-theyre-coming-due-c375494.