'Zombie offices' are causing problems for some banks
Ornate Art Deco buildings that tower over Chicago's main business district report occupancy rates as low as 17 percent.
A number of shiny office towers in Denver, which were packed with tenants and worth $176 million in 2013, are now largely vacant and were last appraised at just $82 million, according to data from Trepp, a real estate lending research firm. keeps track. Even known Buildings in Los Angeles are collecting about half of their pre-pandemic numbers Prices.
From San Francisco to Washington DC the story is the same. Office buildings remain stuck in a slow-burning crisis. Employees who had to work from home at the start of the pandemic have not yet fully returned, a situation that, combined with high interest rates, is wiping out the value of an important class of commercial real estate. Prices for even higher-end office properties have fallen 35 percent from their peak in early 2022, according to data from real estate analytics firm Green Street.
These forces have put the banks, which hold much of U.S. commercial real estate debt, front and center — and analysts and even regulators have said the reckoning has not yet fully occurred. The question is not whether major losses are coming. The question is whether it will prove to be a slow bleed or a panic-inducing wave.
We got a taste of trouble this past week as shares of New York Community Bancorp plummeted after the lender announced unexpected losses on real estate loans tied to both office and apartment buildings.
So far, “the headlines have outpaced the actual stress,” says Lonnie Hendry, chief product officer at Trepp. “Banks are left with a lot of unrealized losses. If that slow leak is exposed, it can be released very quickly.”
Last year's concerns are today's problems.
When a series of banks failed last spring – partly because rising interest rates had lowered the value of their assets – analysts feared that commercial real estate could cause a wider range of problems.
Banks are holding about $1.4 trillion of the $2.6 trillion in commercial real estate loans set to mature over the next five years, based on Trepp data, and small and regional lenders are especially active on the market.
Economists and regulators feared that heavy exposure to the unpredictable-seeming sector could deter bank depositors, especially those with savings above the $250,000 limit for government insurance, and prompt them to withdraw their money.
But government officials responded strongly to the turmoil of 2023. They helped sell failing institutions, and the Federal Reserve set up a low-cost bank financing option. The actions restored confidence and the jitters at the banks disappeared from view.
That has changed in recent days with the problems at New York Community Bancorp. Some analysts dismiss this as a one-off event. New York Community Bancorp took over the failing Signature Bank last spring, compounding the problems. And so far, savers are not withdrawing their money from the banks in large numbers.
But others see the bank's plight as a reminder that many lenders will be hurt, even if it doesn't trigger systemwide panic. The reprieve the government granted the banking system last year was temporary: the Fed's financing program is set to be disabled next month for example. The problems with commercial real estate are permanent.
The pain has yet to be realized.
Commercial real estate is a broad asset class that includes retail, multi-family housing and factories. The sector as a whole has had a few tumultuous years, with office buildings particularly hard hit.
About 14 percent of all commercial real estate loans and 44 percent of office loans are underwater — meaning the properties are worth less than the debt behind them — according to a recent article from the National Bureau of Economic Research by Erica Xuewei Jiang of the University of Southern California, Tomasz Piskorski of Columbia Business School and two of their colleagues.
While major lenders like JP Morgan and Bank of America have begun setting aside money to cover expected losses, analysts say many small and mid-sized banks are downplaying the potential costs.
Some offices are still officially occupied, even though there are few employees present – what Mr Hendry called “zombies” – thanks to years of lease terms. This can make them appear viable when they are not.
In other cases, banks are using short-term extensions instead of taking over distressed buildings or extending now unworkable leases – in the hope that interest rates will fall, which would help boost property values, and that workers will return.
“If they can extend that loan and make sure it continues to yield, they can delay doomsday,” said Harold Bordwin, managing director at troubled real estate brokerage Keen-Summit Capital Partners.
The bank's reported default rates have remained unchanged much lowerjust above 1 percent, then that on commercial real estate loans that are traded in markets, which amount to more than 6 percent. That's a sign that lenders are slow to recognize the construction stress, said Mr. Piskorski, the Columbia economist.
Hundreds of banks are at risk.
But the hope for a turnaround in the office real estate sector seems less realistic.
The return to office trends have stalled. And while the Fed has indicated it does not expect rates to rise above the current level of 5.25 to 5.5 percent, officials have made clear they are in no rush to cut rates.
Mr Hendry expects delinquencies could almost double from the current rate, to between 10 and 12 percent by the end of this year. And as the reckoning continues, hundreds of small and mid-sized banks could be at risk.
Bank asset values have taken a hit amid higher Fed interest rates, Mr. Piskorski and Ms. Jiang found in their paper, meaning mounting losses on commercial real estate could leave many institutions in bad shape.
If that were to throw uninsured savers into turmoil and lead to the kind of bank runs that brought down the banks last March, many could go outright bankrupt.
“It's a game of trust, and commercial real estate could be the trigger,” Mr. Piskorski said.
Their paper estimates that dozens to more than 300 banks could face such a disaster. That may not be a crushing blow in a country with 4,800 banks – especially since small and medium-sized lenders are not as connected to the rest of the financial system as their larger counterparts. But a rapid collapse would risk wider panic.
“There is a scenario where it spills over,” Mr. Piskorski said. “The most likely scenario is slow bleeding.”
Supervisors are attuned to the threat.
Officials at the Fed and the Treasury Department have made it clear that they are keeping a close eye on both the banking sector and the commercial real estate market.
“Commercial real estate is an area that we have long been aware of could create financial stability risks or losses in the banking system, and this is something that requires careful supervisory attention,” Treasury Secretary Janet L. Yellen said during testimony before Congress this week.
Jerome H. Powell, the Fed chairman, acknowledged during a “60 Minutes” interview that aired Feb. 4 that “there will be losses.” For big banks, Mr. Powell said, the risk is manageable. When it comes to regional banks, he said the Fed was working with them to deal with the expected impact, and some would have to close or merge.
“It feels like a problem we will be working on for years,” Mr. Powell. He called the problem “significant” but said that “it does not appear to have the consequences of the kind of crisis situations that we have sometimes seen in the past, for example with the global financial crisis.”
Alan Rappeport reporting contributed.