Brand Story-With the effects of rising interest rates on banks what will the future hold for commercial real estate.
Rising interest rates doomed Silicon Valley Bank (SVB), which was shut down by federal regulators in mid-March after a run on deposits that the bank couldn’t cover. Similar failures followed in other regional banks in New York and San Diego. Commercial real estate relies heavily on the banking industry for capital, with loans and leases on the books of banks reaching $5.31 trillion, an 11.2% increase in the last year. Accordingly, the impact of these bank failures will likely impact CRE more severely than the economy as a whole.
First and foremost, these bank failures will increase scrutiny of loan applications across the industry while banks at the same time seek to reduce their exposure. This double whammy will make loans much harder to get. Regional banks like SVB disproportionately lend to CRE borrowers, so they will face the most scrutiny in the short term. And even loans that close will be more expensive as interest rates continue to rise, although more slowly now than in 2022. A huge wave of refinancings is coming as well, a lot of it in uncertain markets like the office sector. Many borrowers will be hard-pressed to refinance maturing debt in today’s higher interest rate environment, and defaults will disproportionately affect banks since the market for mortgage-backed securities has fallen 75% since its peak in 2007.
SVB and other failed banks also backed a number of high-profile commercial tenants with lines or letters of credit. Replacements may be hard to find for tenants with cash flow challenges due to interest and cap rate hikes, creating greater exposure for some REITs and other institutional landlords. The banks themselves were also anchor tenants in several markets, creating losses for their landlords and significant vacancies in those locations.
Overall, most economists believe that the failures of these banks are not indicative of systemic problems and therefore do not present the same overall risk to the economy as the Great Recession. Unlike 2008, real estate did not cause these failures but will bear the brunt of it. Also unlike 2008, most banks remain well-capitalized so the spread to other loan classes is likely to be minimal. However, the CRE sector is in for a bumpy ride as the fallout from the recent bank failures builds upon challenges that already existed from COVID-19, rising interest rates, changing customer demands, and static-to-declining property values.