Risks in commercial real estate (CRE), particularly for the office sector, have been exacerbated by rising interest rates, people choosing to work from home, and banking stress, according to a report by Moody's Investor Service Tuesday.
Office remains "particularly exposed" as a large share of employees continue to work from home, creating default risk for office real estate loans, which represent $736 billion, or 16.7% of CRE debt outstanding, the report added.
Some strained commercial properties underlying commercial mortgage-backed securities (CMBS) – which represent 16% of CRE debt outstanding – are also likely to have trouble with refinancing.
Moody's analysts expect an economic slowdown to dent revenue growth that had been driven by a post-pandemic demand recovery across multi-family, hospitality, retail and industrial sectors. Analysts expect CRE values in all sectors to soften as economic activity decelerates.
"A broad-based CRE downturn would significantly hurt banks, which hold about half of all outstanding CRE debt and the largest share maturing in 2023-2026," Moody's said.
In April, some of the largest U.S. banks singled out office commercial real estate as an area of growing concern while reporting first-quarter results, with property values falling and more borrowers defaulting on their loans amid rising interest rates and a slowing economy.
Stress in the commercial real estate sector has the potential for broad implications for banks and the economy, as losses emanating there can tighten credit availability and exacerbate a downturn.