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An Overview 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 little banks distributing industrial real estate (CRE) loans. [1] As of June 2024, outstanding CRE loans in America total up to almost $3 trillion, [2] and about $1 trillion will become due and payable within the next 2 years. [3] In addition, CRE loan delinquency rates have actually increased substantially considering that 2023. [4] Roughly two-thirds of the currently exceptional CRE financial obligation is held by little banks, [5] so company owner need to be cautious of the growing capacity for a disastrous market crash in the near future.

As lockdowns, limitations and panic over COVID-19 gradually subsided in America near completion of 2020, the CRE market experienced a rise in demand. [6] Businesses capitalized on low rates of interest and gotten residential or commercial properties at a higher volume than the pre-recession property market in 2006. [7] In lots of ways, companies committed to the concept of a post-pandemic "migration" of employees from their remote positions back to the workplace. [8]

However, contrary to the hopes of numerous company owner, employees have not returned to the office. In fact, workplace vacancy rates reached a record high of 13.2% in 2023. [9] Additionally, considerable post-pandemic development in the e-commerce industry has American shopping malls reaching a record-high vacancy rate of 8.8%. [10] This reduction in demand has resulted in a decline in CRE residential or commercial property worths, [11] thus negatively impacting lending institutions' positions by means of increased loan-to-value ratios (LTV). Yet, while bigger banks have already begun reporting CRE loan losses, small banks have not done the same. [12]

Because many CRE loans are structured in a manner that requires interest-only payments, it is not uncommon for company owner to refinance or extend their loan maturity date to acquire a more beneficial rate of interest before the full principal payment ends up being due. [13] Given the state of the current CRE market, nevertheless, large banks-which undergo more stringent regulations-are likely hesitant to engage in this practice. And since the typical CRE lease term ranges from about 3 to 5 years, [14] many industrial proprietors are fighting versus the clock to avoid delinquency or perhaps defaulting under their loan terms. [15]

The existing lack of reporting losses by small banks is not an indication 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 business sector recover in a timely manner. [17] This is a hazardous video game since it brings the threat of creating inadequate capital for little banks-a result that could result in the destabilization of the U.S. banking system as a whole. [18]

Entrepreneur obtaining CRE loans need to act quickly to increase their liquidity in case they are unable to refinance or extend their loan maturity date and are forced to start paying the principal for a residential or commercial property that does not produce sufficient returns. This needs entrepreneur to deal with their banks to look for a favorable service for both parties in the occasion of a crisis, and if possible, diversify their properties to develop a financial buffer.

Counsel for at-risk services ought to thoroughly evaluate the arrangements of all loan agreements, mortgages, and other documents overloading subject residential or commercial properties and keep management informed as to any terms producing raised dangers for business as set forth therein.

While company owners must not worry, it is important that they begin taking preventative procedures now. The survivability of their services may very well depend on it.

Sources:

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

[2] NAR, business real estate 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 Property, 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 being reliant on the effectiveness of the COVID-19 vaccine versus different variations of the infection).

[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.