A recent academic paper published by the National Bureau of Economic Research suggests that nearly half of all mortgages secured by American commercial office properties are in trouble, raising questions about financial risks at some of the nation’s banks.
A quartet of economists at Stanford University, the University of Southern California, Northwestern University and Columbia University found that 14 percent of all loans in the US, including 44 percent of office loans, appear to be in “negative equity” where their current property values are less than the outstanding loan balances. This could create challenges for property owners when they seek to refinance underwater loans coming due in the coming years, and create challenges for some banks’ balance sheets.
Commercial real estate loans typically run for a much shorter term than residential mortgages, and are often refinanced instead of being paid off.
The researchers looked at data from 35,253 loans totaling to $825 billion in aggregated balance from the commercial mortgage-backed securities market.
The NBER paper stated that the decrease in commercial office values was attributed to the astronomical rise of the interest rates from 2022 to 2023, as well the adoption of hybrid working patterns as fewer people go to offices and instead work remotely or from home.
The paper also noted that delinquency rates on commercial mortgages also jumped from 1.58 percent in December 2022 to 6.08 percent in November 2023.
Economists aren’t the only ones flagging commercial real estate loans as an area of concern for the banking industry in 2024.
The Financial Stability Oversight Council, comprised of top officials from the Treasury Department and the nation’s financial regulators, also pointed to risk in refinancing commercial real estate loans due to the sizeable amount of upcoming maturities in 2024 during its annual report.
“These factors can lead to potential financial stability risks if they result in financial distress among financial institutions and investors that spills over into other financial institutions and the broader system,” the FSOC report stated.
The council added that banks have and will continue to tighten their lending standards not just in offices but in all loan categories due to their desire to improve their capital and liquidity positions, increased concerns about deposit outflows, reduced tolerance for risk, and the uncertainty about the economic outlook.
“The Council recommends that supervisors, financial institutions, and investors continue to closely monitor CRE exposures and concentrations, and to track market conditions,” it said. “They should also continue to evaluate loan portfolios’ resilience to potential stress, ensure adequate credit loss allowances, assess CRE underwriting standards, and review contingency planning for a possibly protracted period of rising loan delinquencies.”