The economic turmoil resulting from the coronavirus pandemic has the potential to massively disrupt commercial real estate (CRE) and hasten loan losses for financial institutions.
Widespread vacancy rates are paralyzing the hospitality industry, while shuttered retail locations are starting to create problems for malls. Brick-and-mortar office properties may experience problems in the future as greater numbers of employees work on a remote basis and their employers realize they can accomplish tasks without the additional costs of overhead.
Collectively, these conditions are likely to produce immediate credit problems that will necessitate long-term adaptation in the CRE industry.
A new study conducted by data firm Trepp analyzing 12,500 CRE loans owned by U.S. banks indicates that losses within the sector could rise from last year’s rates of under 1% to approximately 2.5% in five years’ time. The hospitality industry in particular has the bleakest future, with the study forecasting around a 35% default rate and a 13% anticipated loss.
The primary issues are decreasing rents and climbing vacancy rates, which together would eliminate property owners’ profit margins, along with their ability to meet their loan payments. While multifamily developments and industrial complexes should perform better, their anticipated losses will also increase significantly, according to the study.
The Trepp study estimations were premised on the expected tripling of the national unemployment claim rate coupled with a sharp decline in asset prices. The firm also considered the effects of the COVID-19 pandemic to date, predicting a 35% nosedive in CRE prices over the course of the initial two years. Dropping prices would make it more challenging for property owners to refinance upon loan maturation. CRE industry experts expect significant credit quality fluctuations and rising charge-offs.
The U.S. will most likely enter a recession period in the second quarter. While financial institutions are generally comfortably capitalized and have the ability to absorb short-term losses on loans, the pandemic has the potential to overwhelm certain lenders if the turbulent economic conditions persist after the year’s end.
Due to the rampant nature of the pandemic thus far, CRE analysts are expecting major markets in states like New York, California, and Washington to produce the biggest initial complications.
The short-term economic impact brought about by the pandemic will be severely detrimental to the second quarter GDP; however, some industry analysts are hopeful that emergency federal government measures—most significantly the $2 trillion CARES Act passed late March —will buttress the economy and help it recover in the closing quarters of 2020.
In contrast to the 2008 economic crisis, in which financial institutions were largely to blame for the subsequent recession, lenders began this year with a wealth of capital and on relatively good terms with regulators and government officials—as underscored by the fact that the stimulus bill includes almost $350 billion for low-cost Small Business Administration loans that will guaranteed by the government, but will be originated by banks and other private lending entities. Additionally, restrictive regulatory terms are being eased to assist banks in providing fast relief to struggling clientele.
Although banks have the resources to weather short-term challenges caused by the coronavirus outbreak, they have to be prepared for lasting changes to the CRE industry at large. A potential trend will be a collective decline in the demand for office space developments. With scores of workers employed on a remote basis for the first time in history, a large number of employers are adapting their management strategies for dispersed workforces and looking to cut costs whilst doing so.