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An Overview 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, alerted the Senate Banking Committee about the impending failure of small banks handing out business property (CRE) loans. [1] As of June 2024, impressive CRE loans in America total up to almost $3 trillion, [2] and about $1 trillion will end up being due and payable within the next two years. [3] In addition, CRE loan delinquency rates have increased significantly considering that 2023. [4] Roughly two-thirds of the presently impressive CRE debt is held by little banks, [5] so company owner should watch out for the growing potential for a destructive market crash in the near future.

As lockdowns, restrictions and panic over COVID-19 gradually diminished in America near the end of 2020, the CRE market experienced a rise in demand. [6] Businesses profited from low rates of interest and obtained residential or commercial properties at a greater volume than the pre-recession realty market in 2006. [7] In numerous methods, businesses committed to the idea of a post-pandemic "migration" of employees from their remote positions back to the office. [8]
However, contrary to the hopes of lots of entrepreneur, employees have actually not re-entered the office. In truth, office vacancy rates reached a record high of 13.2% in 2023. [9] Additionally, significant post-pandemic growth in the e-commerce industry has American shopping malls reaching a record-high job rate of 8.8%. [10] This reduction in need has resulted in a decrease in CRE residential or commercial property values, [11] therefore adversely impacting lenders' positions by means of increased loan-to-value ratios (LTV). Yet, while larger banks have already begun reporting CRE loan losses, little banks have actually not followed fit. [12]
Because lots of CRE loans are structured in a method that requires interest-only payments, it is not unusual for company owner to refinance or extend their loan maturity date to get a more beneficial rate of interest before the complete principal payment ends up being due. [13] Given the state of the present CRE market, nevertheless, big banks-which are subject to stricter regulations-are likely hesitant to engage in this practice. And since the common CRE lease term varies from about three to five years, [14] numerous commercial property managers are battling against the clock to avoid delinquency or even defaulting under their loan terms. [15]
The current absence of reporting losses by little banks is not an indicator 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 commercial sector recuperate in a timely manner. [17] This is a dangerous video game since it brings the risk of developing insufficient capital for little banks-an impact that might result in the destabilization of the U.S. banking system as a whole. [18]
Company owner borrowing CRE loans should act rapidly to increase their liquidity in case 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 needs entrepreneur to work with their banks to seek a favorable solution for both parties in case of a crisis, and if possible, diversify their assets to produce a monetary buffer.

Counsel for at-risk organizations ought to carefully examine the provisions of all loan arrangements, mortgages, and other documentation encumbering subject residential or commercial properties and keep management informed regarding any terms creating elevated dangers for the organization as set forth therein.

While entrepreneur ought to not worry, it is crucial that they begin taking preventative steps now. The survivability of their businesses may extremely well depend on it.

Sources:

[1] Tobias Burns, Wall Street braces for business 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 realty 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 Realty, 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. (referring to the "huge re-entry" as being dependent on the efficacy of the COVID-19 vaccine against various variants of the infection).

[9] Fin. stability oversight Council, Annual Report (2023 ).

[10] NAR, supra note 2, at 7.

[11] Peterson, supra note 3.
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[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.