CRE and the Economy – The Real Estate Roundtable

Federal Reserve sunset This week, commercial real estate was a prominent focus of the Federal Reserve’s quarterly senior loan officer opinion survey and announcement about the hypothetical scenarios that 23 banks will be stress-tested against in 2023. (Fed Survey, Feb. 6 and Stress Test, Feb. 9)

2022 Survey & 2023 Stress Test

On Monday, the Fed released its January 2023 Senior Loan Officer Opinion Survey on Bank Lending Practices, which reported tighter standards and weaker demand for all commercial real estate loan categories for the fourth quarter of 2022. The survey also reported that for 2023, banks expect lending standards will tighten, demand will weaken, and loan quality will deteriorate across all loan types. (Reuters, Feb. 6 | American Banker, Feb. 7 | GlobeSt, Feb. 9)
On Thursday, the Fed released the hypothetical scenarios for its 2023 annual stress test, which measures and evaluates the ability of large banks to continue lending to businesses and households during a recession or weakened financial conditions.
The scenarios will include a severe global recession, heightened stress in both commercial and residential real estate markets, and a new, unspecified “exploratory market shock.” The new component will not count against capital requirements affected by the tests, the Fed said. (BGov, Feb. 10)
The Fed detailed additional key features of the “severely adverse scenario” by instructing banks, “Declines in commercial real estate prices should be assumed to be concentrated in properties most at risk of a sustained drop in income and asset values: offices that may be affected by remote work or hospitality sectors that continue to be affected by reduced business travel. Declines in U.S. house prices and U.S. commercial real estate prices should also be assumed to be representative of … those that experienced rapid price gains before the pandemic and were significantly affected by the event.” (pdf of instructions for 2023 Federal Reserve Stress Test Scenarios)

Delinquency Rate & CRE Outlook

Trepp’s CMBS Research reported this week that that the overall US CMBS special servicing rate dropped in January 2023 six basis points to 5.11%—down for the second month in a row after four consecutive increases from August to November. By comparison, the rate one year ago was 6.33% and six months registered at 4.79%. (Trepp, Feb. 8)
The office sector saw a 16-basis point increase in the special servicing rate in January, and it led all new special servicing transfers.
An industry panel discussion on Feb. 6 focused on Cutting Through Uncertainty: 2023 Economic & CRE Outlook. The on-demand webinar is moderated by Roundtable Member Hessam Nadji (President & CEO, Marcus & Millichap), who leads a discussion with Moody’s Analytics Chief Economist Mark Zandy, along with Roundtable Members Wendy Mann (CEO, CREW Network), Tom McGee (President and CEO, ICSC) and Marc Selvitelli (President & CEO, NAIOP).

This month, The Real Estate Roundtable will release its Q1 Economic Sentiment Survey, which will report on how leading CRE executives view current market conditions and their expectations for the year.

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U.S. Treasury Department A council of federal financial regulators chaired by Treasury Secretary Janet Yellen stated in their 2022 Annual Report released today: “the commercial real estate (CRE) and residential real estate sectors have the potential to increase risks to U.S. financial stability significantly.” (Treasury Department news release and PoliticoPro, Dec. 16)

A Top Concern

The Financial Stability Oversight Council (FSOC) identified CRE among its top market and credit concerns heading into 2023, given rising interest rates and borrowing costs. (FSOC Annual Report, pages 18-20)
Among the FSOC’s report conclusions:
- “Rising interest rates, uncertain economic conditions, continuing weakness in urban commercial real estate, and the possibility that some post-pandemic changes in demand for CRE will become permanent have heightened concerns about CRE.”
- “The Council recommends supervisors and financial institutions continue to monitor CRE exposures and concentrations, ensure the adequacy of credit loss allowances, assess CRE underwriting standards, and review contingency planning for a possible increase in delinquencies.”

“In extreme cases, CRE credit losses can lead to outright bank failures, particularly for banks with high exposure to CRE loans,” according to the regulators’ report.

Office Markets & Remote Work

The Council emphasized that the office property market may face the most uncertainty, with the prospect of weak future demand as return-to-office plans evolve and users decide how much space they need.
The 2022 Annual Report notes that office property demand may take time to stabilize as tenants navigate remote work decisions and adjust leasing decisions. The FSOC also reports that a slow return to densely populated urban office centers could reduce the desirability of office properties and nearby retail space.
“This may be especially true for older, less desirable office spaces with fewer modern amenities,” the report acknowledges.
The report also notes, “structural changes in the demand for office space can lead to weaker credit quality for loans secured by office properties over the long term.”

The Fed’s Influence

FSOC regulators also caution that more aggressive action by the Fed—either in its interest rate decisions or changes in its holdings of mortgage-backed securities—could lead to further increases in mortgage rates that could negatively affect financial stability. (FSOC 2022 Annual Report and PoliticoPro, Dec. 16 )

The Council’s mission is to identify risks to the financial stability of the United States, promote market discipline, and respond to emerging risks to the stability of its financial system. (FSOC website)

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Category: CRE and the Economy

Commercial Real Estate a Focus of Fed Loan Officer Survey and Bank Stress Test Plans

Federal Regulators Identify CRE as a Risk to U.S. Financial Stability