Elevated commercial real estate valuations are increasingly viewed as a near-term risk that could stress the U.S. financial system, according the Federal Reserve’s October 2023 Financial Stability Report. The central bank’s semiannual report also cited inflationary pressures, interest rate increases, and global economic volatility as vulnerabilities—even though survey data was collected before the recent escalation of geopolitical tensions in the Middle East. (Fed’s Financial Stability Report, Oct. 2023)
CRE Risk Emphasized
- Seventy-two percent of all participants in the Fed’s survey cited the potential for large losses on commercial real estate and residential real estate—along with persistent inflation and monetary tightening—as major risks.
- The CRE asset valuation problem noted in the Fed Report is influenced by an ongoing lack of price discovery, which creates significant refinancing challenges. GlobeSt reported Oct 24 on the report, noting that “With transactions down and many sellers holding off, waiting for improved pricing while a lot of buyers look for bargains in distress, it’s hard to tell how much properties should be worth.”
WorkPlace Return Pressure
- The Fed report warns, “If the economy were to slow unexpectedly … investor risk appetite and asset prices might decline, and valuations in the office building sector appear particularly vulnerable given the ongoing uncertainty surrounding post-pandemic norms regarding return to work. A correction in office property valuations accompanied by even a mild recession could result in significant losses for a range of financial institutions with sizable exposures, including some regional and community banks and insurance companies.”
Additional risks that continued to feature prominently in the Fed survey were associated with the reemergence of banking-sector stress, market liquidity strains, and volatility.
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A new Real Estate Roundtable report—Commercial Real Estate By The Numbers: 2023— illustrates CRE’s significant contributions to the economy, statistics on climate and the industry, and the important role of tax policy in CRE investment. (18-page report)
Statistical CRE Reference
- Roundtable President and CEO Jeffrey DeBoer said, “Our compilation of publicly available data shows the vital role commercial real estate plays as a driving force in the American economy. Whether it is real estate’s positive contributions to GDP, the workforce, local tax bases, or Americans’ retirement savings, this report serves as a valuable resource in understanding the important role of CRE in our society.”
- DeBoer added, “Our report also presents data on CRE’s climate footprint, information on the economic impact of real estate tax proposals, facts on the affordable housing shortage, and statistics on the physical footprint of U.S. commercial real estate. We intend for this reference to be a ‘living document’ that can be updated when new government and private sector statistics become available.”
- The report’s findings, footnoted throughout the publication, include:
- The total value of America’s commercial real estate is estimated between $18- $22 trillion. The value of America’s commercial real estate is nearly 39%-47% of the market capitalization of all U.S. publicly traded companies. The U.S. multifamily housing sector alone is worth $3.8 trillion—worth more than the value of Microsoft, Google, and Amazon combined.
- The combined economic contributions of new commercial building development and the operations of existing commercial buildings contributed an estimated $2.3T to GDP in 2022.
- If U.S. commercial real estate was a country it would have the eighth-largest economy in the world as measured by GDP.
- The commercial real estate industry supports 15.1 million jobs in the U.S.
- CRE pays $559B in property taxes to local governments annually—comprising 72% of all local tax revenue. Commercial real estate owners pay property taxes that are 1.7X more, on average, than the tax rates paid by homeowners.
- Pension funds, educational endowments, and charitable foundations have invested $900B in real estate. 87% and 73% of public and private sector pension funds, respectively, contain real estate investments.
- The commercial and residential sectors represent 13% of total U.S. greenhouse gas emissions. This figure does not include “Scope 3” supply chain emissions beyond the direct control of CRE owners and developers—such as from tenant operations in leased spaces, and carbon embodied in the manufacturing process of cement, steel and other construction materials. (See March 17 Roundtable Weekly, “Reports Confirm Challenges in Scope 3 Reporting”)
Download the 18-page pdf of The Roundtable’s Commercial Real Estate By The Numbers: 2023.
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Federal Reserve Chairman Jerome Powell testified this week before congressional committees on the state of the economy, identifying commercial real estate as an area the central bank is “very focused on” as the office sector faces significant pressures from declining demand and remote work issues.
Banks & CRE
- During the Senate hearing, committee member Bob Menendez (D-NJ) said he was concerned CRE mortgages could be “a ticking time bomb” for many banks as office property values decline and interest rates increase. Powell noted, “We’re being pretty proactive about reaching out to these institutions and trying to help them get through these significant issues.” Click on video clip above to watch the Menendez-Powell exchange or scroll to :31:33 in the full Senate hearing.
- In his opening remarks, House Financial Services Committee Chairman Patrick McHenry (R-NC) stated, “Now we are told these (bank) runs represent a systemic threat to the stability of our financial system. Add in the commercial real estate exposure facing financial institutions and it becomes very easy to understand the mounting anxiety of consumers and job creators. I share in that anxiety.” (Scroll to 1:44 in the House hearing)
- McHenry, above, also warned, “… a massive increase in capital standards for medium and large institutions… would limit banks’ ability to lend money, exacerbating the looming credit crunch, and starving families and small businesses of the capital they need.” (The Roundtable wrote to federal regulators on March 17 about the importance of not engaging in pro-cyclical policies such as requiring financial institutions to increase capital.)
- Rep. Young Kim (R-CA) asked Powell during the House hearing if the Fed is thinking about policies that could provide time for refinancing commercial real estate loans—a position strongly advocated by The Real Estate Roundtable. Powell answered, “There’s a playbook for working your way out of these loans. And it’s particularly in the office sector where work from home is still a material factor in some areas.” (Scroll to 1:26:04 in the House hearing for Kim-Powell exchange)
- On June 16, a statement from the Financial Stability Oversight Council—which includes the heads of the Federal Reserve, the Treasury Department, and the Securities and Exchange Commission—addressed the results of their recent meeting where potential risks in the CRE market were on the agenda. The group commented, “Regulators are taking steps to emphasize risk management and examine exposures to CRE loans at their regulated institutions.”
- On June 21, CNBC’s Last Call interviewed Roundtable Board Member Scott Rechler, above right, (Chief Executive Officer and Chairman, RXR) on how a rise in office vacancies could have sweeping implications for the economy. Roundtable Board Member Barry Sternlicht (Chairman and CEO, Starwood Capital Group) joined CNBC’s Squawk Box on June 22 for a discussion about the Fed’s inflation fight and commercial real estate.
- The dropping value of various investments, including offices that provide crucial property taxes to fund municipalities, were the focus of a June 20 Wall Street Journal report “Wall Street Sours on America’s Downtowns.”
- Real Estate Roundtable President and CEO Jeffrey DeBoer recently remarked on The Roundtable’s Q2 Sentiment Index findings and the role federal regulators can play as CRE faces these significant market developments. “Federal financial institution regulators must act quickly to provide greater supervisory flexibility—as they did in 2009, 2020, and 2022—to allow lenders and borrowers to responsibly restructure the large amount of maturing commercial real estate loans,” DeBoer said. (Roundtable Weekly, June 9)
“Businesses and individuals need more time to transition their space needs to the post-pandemic economy. Greater certainty in demand will allow commercial real estate markets, particularly the office sector, to stabilize and revert to its dominant position as the source for local budget revenue. In addition to regulatory flexibility, positive public and private action to encourage in-person, return-to-work policies is needed, where appropriate. As some buildings will need to be reimagined entirely, policy reforms are needed to encourage those buildings to convert to other uses such as housing,” DeBoer added.
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The Real Estate Roundtable’s Q2 2023 Sentiment Index dropped to an overall score of 41, three points lower than the previous quarter. Commercial real estate executives noted how remote work, high interest rates, operating cost escalations, and difficult price discovery has led to significant uncertainty in the post-pandemic office sector and reduced liquidity for nearly all commercial real estate asset classes.
Stress in Office Sector Threatens Cities, Jobs
- Industry leaders also reported relatively healthy Q2 demand for industrial, multifamily, and strip center retail assets. Solid rental growth in multifamily, senior, student, and assisted living sectors was another positive trend reported by sentiment survey participants. (See entire Q2 report.)
- Roundtable President and CEO Jeffrey DeBoer, below, said, “The commercial real estate market is at the center of a major transition. Maturing office loans in particular face a new environment of higher operating and financing costs, much tighter bank lending requirements, and uncertainty in business space needs.”
- “However, while there is relatively good current news from non-office CRE sectors, the combination of reduced liquidity, increased costs, and post-pandemic business uncertainty threatens to spread to these other sectors as well—and potentially cause great damage to communities, jobs, and the economy. Federal financial institution regulators must act quickly to provide greater supervisory flexibility—as they did in 2009, 2020, and 2022—to allow lenders and borrowers to responsibly restructure the large amount of maturing commercial real estate loans.”
- “Businesses and individuals need more time to transition their space needs to the post-pandemic economy. Greater certainty in demand will allow commercial real estate markets, particularly the office sector, to stabilize and revert to its dominant position as the source for local budget revenue. In addition to regulatory flexibility, positive public and private action to encourage in-person, return-to-work policies is needed, where appropriate. As some buildings will need to be reimagined entirely, policy reforms are needed to encourage those buildings to convert to other uses such as housing,” DeBoer added.
- The Roundtable’s Sentiment Index—a measure of senior executives’ confidence and expectations about the commercial real estate market environment—is scored on a scale of 1 to 100 by averaging the scores of Current and Future Sentiment Indices. Any score over 50 is viewed as positive.
- The Q2 Sentiment Index topline findings include:
- The Q2 2023 Real Estate Roundtable Sentiment Index registered an overall score of 41, a decrease of three points from the previous quarter. The Current Index registered 27, a four-point decrease from Q1 2023, and the Future Index posted a score of 55 points, a decrease of three points from the previous quarter.
- Participants noted the continued disparity between asset classes as well as within them. On one hand, rental demand continues to hold up in the multifamily and industrial sectors. Hotel and retail markets are also largely performing well and niche asset classes continue to generate interest and attract capital. On the other hand, while Class A offices remain desirable, the rest of the office industry is struggling to reposition itself.
- Similar to last quarter, 93% of survey participants believe that asset values have repriced to the downside vs. last year. However, limited trades in 2023 are making it difficult to gauge the market. Survey respondents continue to observe wide disparities in bid-ask spreads.
- The availability of capital, both debt and equity, continues to be a pressing topic. Regarding the availability of debt and equity, 93% and 75% of survey participants, respectively, believe that today’s conditions are more difficult than a year ago. While the cost of capital has universally increased, platform scale and relationships largely determine access and ability to secure debt financing.
- Looking to the future, 48% of survey participants stated general market conditions will be more favorable a year from now—although only 20 percent of respondents believe asset values will be more favorable in one year.
- Data for the Q2 survey was gathered in April by Chicago-based Ferguson Partners on The Roundtable’s behalf. See the full Q2 report.
The Real Estate Roundtable brings together leaders of the nation’s top publicly-held and privately-owned real estate ownership, development, lending and management firms with the leaders of major national real estate trade associations to jointly address key national policy issues relating to real estate and the overall economy.
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