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An Overview of the Impending Commercial Real Estate Crisis for Businesses

By Adam Esquivel,
Smith Business Law Fellow
J.D. Candidate, Class of 2025

Earlier this year, Jerome Powell, Chair of the Federal Reserve, warned the Senate Banking Committee about the upcoming failure of small banks distributing business realty (CRE) loans. [1] As of June 2024, exceptional CRE loans in America total up to nearly $3 trillion, [2] and about $1 trillion will end up being due and payable within the next two years. [3] In addition, CRE loan delinquency rates have increased substantially because 2023. [4] Roughly two-thirds of the currently impressive CRE debt is held by small banks, [5] so company owner must be cautious of the growing capacity for a destructive market crash in the near future.

As lockdowns, limitations and panic over COVID-19 gradually diminished in America near completion of 2020, the CRE market experienced a surge in demand. [6] Businesses taken advantage of low rate of interest and acquired residential or commercial properties at a greater volume than the pre-recession property market in 2006. [7] In many methods, organizations devoted to the idea of a post-pandemic "migration" of employees from their remote positions back to the workplace. [8]

However, contrary to the hopes of numerous company owner, workers have actually not re-entered the workplace. In truth, office vacancy rates reached a record high of 13.2% in 2023. [9] Additionally, considerable post-pandemic development in the e-commerce industry has American malls reaching a record-high job rate of 8.8%. [10] This decrease in need has led to a reduction in CRE residential or commercial property worths, [11] hence adversely impacting lenders' positions through increased loan-to-value ratios (LTV). Yet, while bigger banks have currently started reporting CRE loan losses, little banks have actually not done the same. [12]

Because lots of CRE loans are structured in a manner that needs interest-only payments, it is not unusual for company owner to re-finance or extend their loan maturity date to obtain a more favorable rate of interest before the full primary payment ends up being due. [13] Given the state of the current CRE market, nevertheless, large banks-which undergo stricter regulations-are most likely unwilling to take part in this practice. And since the normal CRE lease term ranges from about 3 to five years, [14] numerous business proprietors are combating against the clock to prevent delinquency and even defaulting under their loan terms. [15]

The current lack of reporting losses by little banks is not an indication that they are not at danger. [16] Rather, these institutions are most likely extending CRE loan maturities with their fingers crossed, hoping that residential or commercial property worths in the industrial sector recover in a timely manner. [17] This is a hazardous video game because it carries the risk of producing inadequate capital for little banks-an impact that could cause the destabilization of the U.S. banking system as a whole. [18]

Business owners borrowing CRE loans ought to act rapidly to increase their liquidity in the event that they are unable to re-finance or extend their loan maturity date and are forced to start paying the principal for a residential or commercial property that does not produce enough returns. This needs company owners to deal with their banks to look for a favorable solution for both parties in case of a crisis, and if possible, diversify their properties to produce a monetary buffer.

Counsel for at-risk organizations must thoroughly review the provisions of all loan agreements, mortgages, and other documentation encumbering subject residential or commercial properties and keep management informed as to any terms developing raised threats for the organization as set forth therein.

While entrepreneur must not worry, it is crucial that they start taking preventative measures now. The survivability of their businesses may extremely well depend on it.

Sources:

[1] Tobias Burns, Wall Street braces for business property time bomb, The Hill: Business (Mar. 14, 2024) https://thehill.com/business/4526847-wall-street-braces-for-commercial-real-estate-timebomb/amp/.

[2] NAR, commercial realty market insights report 4 (2024 ).

[3] Dana M. Peterson, U.S. Commercial Real Estate Is Heading Toward a Crisis, Harv. Bus. Rev.: Corporate Finance (July 23, 2024) https://hbr.org/2024/07/u-s-commercial-real-estate-is-headed-toward-a-crisis.

[4] Id. (CRE loan delinquency rates were.77% in 2023 and 1.18% in 2024).

[5] Id.

[6] Milton Ezrati, Covid's Long Shadow Still Spreads Over Commercial Realty, Forbes: Leadership Strategy (Mar. 17, 2023) https://www.forbes.com/sites/miltonezrati/2023/03/17/covids-long-shadow-still-spreads-over-commercial-real-estate/.

[7] Scholastica Cororaton, Commercial Weekly: Commercial Real Estate Outperforms Expectations in 2021 and is Poised to Strengthen in 2022, NAR: Economist's Outlook (Dec. 23, 2021) https://www.nar.realtor/blogs/economists-outlook/commercial-weekly-commercial-real-estate-outperforms-expectations-in-2021-and-is-poised-to.

[8] Id. (describing the "huge re-entry" as depending on the efficacy of the COVID-19 vaccine versus different variants of the virus).

[9] Fin. stability oversight Council, Annual Report (2023 ).

[10] NAR, supra note 2, at 7.

[11] Peterson, supra note 3.

[12] Id.

[13] Konrad Putzier, Interest-Only Loans Helped Commercial Residential Or Commercial Property Boom. Now They're Coming Due., WSJ: Residential Or Commercial Property Report (June 6, 2023) https://www.wsj.com/articles/interest-only-loans-helped-commercial-property-boom-now-theyre-coming-due-c375494.