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A Summary 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, cautioned the Senate Banking Committee about the upcoming failure of little banks handing out industrial real estate (CRE) loans. [1] As of June 2024, impressive CRE loans in America quantity to nearly $3 trillion, [2] and about $1 trillion will become due and payable within the next two years. [3] In addition, CRE loan delinquency rates have increased substantially given that 2023. [4] Roughly two-thirds of the presently impressive CRE financial obligation is held by little banks, [5] so company owner ought to be cautious of the growing potential for a devastating market crash in the future.

As lockdowns, limitations and panic over COVID-19 gradually subsided in America near completion of 2020, the CRE market experienced a surge in need. [6] Businesses capitalized on low rate of interest and gotten residential or commercial properties at a higher volume than the pre-recession real estate market in 2006. [7] In many ways, companies devoted to the concept of a post-pandemic "migration" of employees from their remote positions back to the workplace. [8]

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

Because many CRE loans are structured in such a way that requires interest-only payments, it is not uncommon for business owners to re-finance or extend their loan maturity date to obtain a more favorable rates of interest before the complete principal payment becomes due. [13] Given the state of the existing CRE market, however, large banks-which go through stricter regulations-are likely unwilling to take part in this practice. And since the common CRE lease term ranges from about three to 5 years, [14] numerous commercial property managers are combating versus the clock to avoid delinquency and even defaulting under their loan terms. [15]

The existing lack of reporting losses by little banks is not an indication that they are not at danger. [16] Rather, these organizations are likely extending CRE loan maturities with their fingers crossed, hoping that residential or commercial property worths in the business sector recuperate in a prompt manner. [17] This is a dangerous video game due to the fact that it carries the danger of producing inadequate capital for little banks-a result that might result in the destabilization of the U.S. banking system as a whole. [18]

Entrepreneur obtaining CRE loans must act rapidly to increase their liquidity in the occasion that they are unable to re-finance or extend their loan maturity date and are required to start paying the principal for a residential or commercial property that does not produce adequate returns. This requires entrepreneur to work with their banks to seek a beneficial solution for both parties in case of a crisis, and if possible, diversify their possessions to produce a financial buffer.

Counsel for at-risk services must thoroughly examine the provisions of all loan contracts, mortgages, and other documents encumbering subject residential or commercial properties and keep management notified as to any terms creating elevated threats for business as set forth therein.

While entrepreneur ought to not worry, it is important that they start taking preventative measures now. The survivability of their organizations may extremely well depend on it.

Sources:

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

[2] NAR, business property 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 Property, 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 being dependent on the efficacy of the COVID-19 vaccine versus different versions of the infection).

[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.