A sharp downturn in commercial real estate performance could have a big impact on the banking sector, but not big enough to destabilize the financial system, according to analysis from one of the top real estate economists in the country. More than 300 banks have enough commercial real estate loans on their books to see their Tier 1 capital wiped out under a worst-case scenario, Richard Barkham, chief economist and head of research at CBRE, said this week during a conference hosted by the National Association of Real Estate Editors.
Barkham said the real estate advisory firm analyzed Federal Deposit Insurance Corp. data on the balance sheets of 4,800 insured banks to identify the banking sector’s total exposure to commercial real estate. It then applied a hypothetical stress scenario in which property values and net operating incomes fell enough to result in a total loss.
Under this extreme, but unlikely scenario, Barkham said 311 banks would fail, with the vast majority being community banks, along with about 20 regional banks and one large bank. He did not identify which banks are most exposed to this risk. Barkham said the assets of the failed banks in the scenario totaled about $600 billion, roughly three times the size of Silicon Valley Bank, which failed in March.
“This is going to be a problem for bank earnings. Banks are going to have to write down the loans, write down their earnings, but there isn’t enough here to bring down the banking system,” Barkham said. “It’s irresponsible, I think, to suggest that it will.”
Barkham argued that there is little reason to believe that commercial real estate could drag down the banking sector in the way the residential mortgage market did in 2008. He noted that the residential real estate sector totals about $43 trillion, while all of commercial real estate accounts for just $21 trillion, with office properties, the most embattled property type, accounting for 20% of that total.
“In terms of the scale of the value loss feeding through to loan loss, it’s entirely different from what we saw during the great financial crisis,” he said. “I’m not saying it isn’t a problem. I’m just saying don’t analog the great financial crisis with the current issues in commercial real estate.”
Conclusion, there is trouble brewing in Commercial real estate, especially in the Office sector however it will likely be an earnings issue for the banks versus a systemic issue for the entire sector in past cycles. This will be especially pertinent in 2023, as this year has the largest maturity schedule of outstanding Commercial real estate debt coming due until at least 2032. Cohen and Steers has broken out this maturity schedule by sector and vehicle in billions of dollars below.
