Will commercial real-estate crisis hit US banks?
The problem with the commercial real estate market is seen as a systemic threat by some institutions, such as Wells Fargo and Morgan Stanley, although it is not yet clear whether it is really on such a scale.
According to Green Street data, the value of commercial real estate in the U.S. is already down 25% year-over-year, and vacancy rates are also rising:
• Brookfield (BN.US) and Blackstone (BX.US) funds have significant exposure to commercial real estate. Blackstone already reported its results for the first quarter 2023 and under GAAP, Blackstone reported net income of just $211 million, down from $2.5 billion in the prior year, owing to the drop in asset sales as well as a decline in the value of its assets.
• Brookfield has already defaulted on nearly $161 million in commitments for office buildings in Washington (DC) because they are vacant, but continues to seek a deal;
• The fund’s problems, previously valued at about $784 million, involved properties in Los Angeles (777 Tower, Gas Company Tower), but now a dozen other office buildings are also affected;
• According to Bloomberg, Columbia Property Trust, Pacific Investment Management, and WeWork and Rhone Group are also struggling to pay down debt and meet their obligations.
Brookfield points out that 95% of its real estate portfolio consists of high-end properties, and demand continues unabated.
At the same time, commercial real estate prices in the Washington metropolitan area are down 36% year over year, and compared to pre-pandemic levels, only 43% of workers in the region need to go to the office at least once a week, according to Kastle Systems.
Remote work is also popular in other U.S. states. Among the 12 largest office properties in Brookfield’s portfolio, the occupancy rate was 52% in 2022, down from 79% in 2018.
At the same time, monthly variable mortgage rates rose to about $880,000 in April, up from just over $300,000 in 2021.
Will Commercial Real Estate (CRE) affect the banks?
• OakTree estimates that banks in the U.S. hold about $1.8 trillion of the $4.5 trillion in outstanding mortgages (about 40 percent), and commercial real estate loans (CRE) account for about 8 to 9 percent of the average bank’s assets (excluding the share of commercial mortgage-backed securities);
• Given the leverage of the banking sector, equity amounts to about $2.2 trillion, so a 9 percent share of assets would imply an equity ratio of up to 100 percent, which could herald the ‘undercapitalization’ of many banks;
• According to the BofA report, the average large bank has nearly 50% of its risk capital in CRE loans, a much larger exposure than smaller banks – up to 167%.
According to OakTree, the average CRE exposure is 4.5% of assets for banks over $250 billion and over 11% for banks under $250 billion;