Commercial real estate crisis could hurt small banks

Another round of quarterly bank earnings came in the past few days. Not for the biggest banks, but mostly for the big regional banks.

But the picture is not very pretty. High interest rates – likely to remain high for a long time, the Federal Reserve warns – are hurting profits. On Thursday, KeyCorp, Comerica and Ally all informed of That their net income fell. on wednesday it was a similar story From US Bancorp and Citizens Financial.

One thing that impacts this sector is commercial real estate. These banks have a lot of CRE loans on their books, hit by the double whammy of higher interest rates and higher office vacancies from the pandemic-era shift to remote work.

Further evidence of this trend came from ATTOM, which tracks real estate data across the country: Commercial property foreclosures had increased. More than 100% — 117%, to be exact — from March 2023 to March 2024.

Commercial real estate includes four property types: industrial, retail, multifamily, and office. And it's clear which is the weakest link, said Suri Sharma at Morningstar. “The real tension is in the offices. There is absolutely no doubt about it,” he said.

How much stress?

“Commercial office space is in deep recession. We're experiencing the extreme downturn of the great financial crisis of 2007 and 2008, said Susan Wachter, a real estate professor at the Wharton School of the University of Pennsylvania.

“This is a crisis,” she said. “But this is a contained crisis and a slow-moving crisis. “If we continue to have strong growth without interest rate hikes and a recession, the pain in the overall economy will remain under control.”

But not for building owners, who are struggling with half-empty office towers and perhaps not bringing in enough rent to pay off their bank loans.

Morningstar's Sharma said the biggest banks should be fine. But smaller, local banks may have 40% to 50% of their portfolio in commercial real estate.

“So if things go bad, there's a very real possibility that some of these banks will go under,” he said.

Now, commercial real estate also includes industrial property, which Ken Simonson, chief economist for the Associated General Contractors of America, said is on the decline.

“There has been very strong growth in data centers and manufacturing plants, infrastructure, and a number of renewable energy projects ranging from solar power to battery storage and maybe some offshore wind,” he said.

As far as retail is concerned, Sharma said it is in quite good shape. And, a huge wave of new multifamily apartment buildings is about to hit the market.