After the COVID-19 pandemic, the focus has been on the increasing inflation and the measures taken to address it, such as raising interest rates. However, there is another significant concern that could have widespread consequences for both consumers and the economy: commercial real estate. In the next two years, there will be a substantial increase in the amount of commercial real estate loans, with a value of around $1.5 trillion, reaching their maturity.
This situation could have a detrimental impact on the construction and development in major cities that are struggling to recover from the effects of the pandemic. The tightening of lending conditions and the refinancing of loans at higher and unsustainable rates could potentially hinder the recovery process.
To prevent further economic uncertainty, it is essential for the Federal Reserve and the financial services regulatory agencies to provide borrowers, including corporate real estate developers, with more time to restructure their commercial real estate loans. This approach has been successful in the past, as it allowed financial institutions to work collaboratively with borrowers during the 2008-09 financial crisis and the COVID-19 pandemic. In 2022, the Fed’s Board of Governors proposed a similar policy, recognizing the need to grant borrowers additional time to adapt to the economic climate. This approach is preferable to pushing for loans that may result in increased foreclosures and bankruptcies.
The consequences of inaction will extend beyond those who hold these loans. The combination of higher interest rates, decreased real estate values, and an illiquid market creates a perfect storm that will burden consumers, businesses, hinder affordable housing expansion, and further endanger the well-being of major metropolitan areas.
It is important to consider that the majority of commercial real estate loans were secured when interest rates were near zero, significantly lower than the current rates, which hover around 5%. Moreover, real estate values have dropped significantly, particularly in cities where high vacancy rates persist due to remote work policies. Before the pandemic, 95% of U.S. offices were occupied, whereas today, that number stands at around 47%. According to the U.S. National Bureau of Economic Research (NBER), this drop has resulted in a loss of $453 billion in commercial real estate value.
Therefore, the federal government must take action to mitigate further harm. In February, defaults on commercial real estate loans reached a 14-year high. Allowing more time for the markets to stabilize has proven effective in the past and can be so again. Granting borrowers additional time will enable them to navigate through the challenges posed by the pandemic and ensure that the public does not bear the brunt of the consequences.