The Trillion Dollar Looming Crisis – How Commercial Real Estate Could be the Next Domino to Fall?
By GENCO CAPITAL
How Commercial Real Estate could be the next domino to fall?
The commercial real estate market is in the midst of a perfect storm that could potentially create a financial crisis of epic proportions. Interest rates are soaring, while office vacancies have hit a record high. With $1.5+ trillion in commercial real estate debt set to mature by 2025, refinancing these loans in the face of these challenges could prove to be an insurmountable task.
The commercial real estate industry is estimated to have a market size of ~$20T. To put that in perspective, the value of U.S. commercial real estate is more than half of the market value of all U.S. publicly traded companies (stocks).
Traditionally, when commercial real estate debt matures, refinancing is accompanied by a reduction in interest rates. But with interest rates on mortgages more than doubling in just two years, the prospect of refinancing these loans has become increasingly daunting.
Compounding the problem is the fact that smaller banks have taken on a higher percentage of commercial real estate loans. While this trend has been evident for some time, new data reveals that small banks now hold 27% of commercial real estate debt, up from 17% in 2017. In fact, smaller banks rely on these loans as much of their business is derived from commercial real estate.
We’ve already seen the early signs of issues with the regional banking sector when multiple banks collapsed. Can they handle another major headwind such as this?
The biggest problem of all is the record high office vacancy rate. In the US, office space available for lease has hit 16.4%, with some cities seeing much higher rates. In Chicago, the vacancy rate is a staggering 20%, while in San Francisco, 13 tech companies have 3.5 million square feet of space available for sublease.
This trend shows no signs of abating, with new research suggesting that up to 330 million square feet of US office space will be vacant by 2030. That’s a 55% increase in the vacancy rate from current levels. The primary drivers of this shift are the rise of remote and hybrid work trends, which are changing the way we work and live.
All of this adds up to a looming debt crisis that could have dire consequences for the commercial real estate industry. With so many office buildings sitting empty, revenue for commercial real estate developers is sure to take a hit. Refinancing and even making payments on these properties will become increasingly difficult, potentially leading to a wave of defaults and foreclosures.
I write this article as a warning. This could add another major obstacle with cascading effects for us to learn how to navigate. As always, I’ll be monitoring how things unfold and reporting back to you.