Office real estate value likely to plunge 26% through 2025: Moody’s

Dive Brief:

  • The value of office commercial real estate will likely plunge 26% by the end of next year as many companies adjust to the work-from-home trend by shrinking work space or moving to cheaper properties, Moody’s Analytics said.
  • Valuations across all CRE types will probably slump 10% peak-to-trough during the next 18 months, Moody’s said Thursday in a report, adding “the office subsector will by far be hit the hardest.”
  • Although CRE accounts for nearly a quarter of bank loans and the largest portion of bank debt, “there is ample evidence that banks are equipped to handle the challenges ahead,” Moody’s said. Still, “there is risk that even minimal signs of stress could amplify into broader crises of confidence in the banking system.”

Dive Insight:

Federal Reserve Chair Jerome Powell predicted this month that CRE losses will mostly harm small- and medium-size banks and cautioned that efforts to ensure stability will need to persist for many years.

“There will be losses by some banks,” Powell said in testimony to the House Financial Services Committee on March 6. “It’s really medium- and small-size banks that have these higher concentrations” of troubled loans, he said, adding “it’s going to be a problem we’ll be working through, I think, for several years.”

The Fed, Treasury, bankers and CRE executives for months have warned of potential market turbulence as property owners struggle to refinance debt at higher rates. The central bank, seeking to curb inflation to 2%, has held the benchmark interest rate since July at a 23-year high.

The Financial Stability Oversight Council of top U.S. regulators in December flagged CRE as a leading risk to financial stability this year, noting rising vacancy rates, declining values of office properties, the possibility of an economic slowdown and high interest rates.

An above-average amount of CRE debt will mature this year and in 2025, with many loans featuring large balloon payments that will probably need to be refinanced, according to Moody’s.

“Even with interest rates expected to inch down this year, borrowers will have to refinance at a much higher interest rate, increasing the risk of cash flow issues,” Moody’s said.

Commercial property owners have faced unusual stress since 2022 as “higher interest rates have lured capital away from CRE in favor of lower-risk, yet newly lucrative fixed-income investments,” Moody’s said.

The value of the multifamily CRE subsector will likely decline 5% during the next six quarters as builders increase supply, Moody’s said.

Industrial and warehouse CRE will probably suffer 5.7% and 6.6% setbacks in valuation during the period, respectively, according to Moody’s. Retail CRE prices will probably decline 8% during the next five quarters as online shopping takes a bigger share of overall sales.

“The commercial real estate market has undergone significant upheaval in recent years,” Moody’s said. “Prices soared from 2020 to 2022, buoyed initially by easy monetary policy and loose credit conditions, and then by demand from investors as a hedge against inflation.”

CRE prices then tumbled 11% after the Fed started raising interest rates in March 2022, erasing gains of the prior two years, according to the International Monetary Fund.

“Moreover, lending standards on CRE loans have grown tighter since the midpoint of 2022,” Moody’s said.

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