Janet Yellen is “concerned” and sees “a lot of stress” ahead for commercial real estate (2024)

These factors “will put a lot of pressure on the owners of these properties,” Yellen told the House Financial Services Committee on Tuesday. He cited a rise in interest rates and higher vacancy rates resulting from a shift toward hybrid and remote work, as well as a number of commercial real estate loans that will soon come due.

About $325 billion in loan maturities are coming due, said Kevin fa*gan, head of CRE economic analysis at Moody’s Analytics. Fortuneand some loans will have trouble refinancing at higher interest rates, further slowing demand for commercial real estate.

“The current performance vulnerability of CRE properties is highly concentrated among office properties, particularly those with short-term loan maturities and high lease renewals,” he said.

Federal Reserve Chairman Jerome Powell also expressed concern this week about the commercial real estate market, particularly its effects on the banking industry. “It seems like a problem we’ll be working on for years,” he told CBS in a 60 minutes interview on Sunday, adding that “it is a considerable” but “manageable” problem that largely affects small and regional banks.

Yellen agrees that regulators have the situation under control, but there is still cause for concern.

“I’m worried,” she said. “I think it’s manageable, although there may be some institutions that are quite stressed by this issue.”

The state of the commercial real estate market.

The pandemic has transformed several business sectors, with office space taking the biggest hit. Coworking giant WeWork filed for bankruptcy, Wells Fargo abandoned its 550,000-square-foot eponymous tower in Raleigh, North Carolina, and countless institutions large and small continued to shed office space they no longer needed.

In fact, up to 330 million square feet of U.S. office space could be vacant by 2023, due to remote and hybrid work, according to a 2023 report from global real estate firm Cushman & Wakefield. Additionally, an additional 740 million square feet of office space will become vacant due to “natural causes” by the turn of the decade, leaving about one billion square feet of office space unused, the report predicted.

While high vacancy rates certainly play a role in commercial real estate’s woes, they are only part of the picture.

“The story is less about the value of commercial real estate — although low occupancy rates in retail spaces and office buildings after COVID play a role — and much more about existing financing,” Michael Imerman, assistant professor at Paul Merage School of Business, which focuses on banking and risk management, said Fortune.

Many commercial developers and investors took out loans after the global financial crisis when interest rates were low, Imerman said. Because these loans have maturities of 10 to 20 years, they will mature soon.

“As interest rates have risen so much over the last 18 months, the owners of these properties (developers and investors) will have to refinance at a much higher rate,” Imerman said. “Add to that the low occupancy rates, (and) there is no way for these loans to be repaid, which will lead to a huge amount of delinquencies on commercial real estate loans in the coming years.”

The Federal Reserve and Treasury say the problem is “manageable”

Speaking more specifically about failing banks, Powell has said that “the system could suffer losses” as a result of the commercial real estate market crash. That was in June 2023, just months after the Federal Reserve took extraordinary measures to prevent banking contagion following the collapse of Silicon Valley Bank, then the second largest in US history.

Yellen also said the Financial Stability Oversight Council was closely monitoring both commercial and residential real estate risks in 2023.

“When two regional banks failed last March, we acted quickly to prevent contagion to banks with similar vulnerabilities and maintain confidence in the banking system,” he said in comments prepared for this week’s congressional hearing. “The Council also increased transparency this year, issuing an analytical framework that for the first time provides the public with detailed information on how it monitors, assesses and responds to potential financial risks.”

Yellen promised that the Treasury would continue to closely monitor the space. “Commercial real estate is an area that we have long known could create risks to financial stability or losses in the banking system,” Yellen said. “This is something that requires careful supervisory attention.”