'Is commercial real estate the next picture ready to fall?'

While it is difficult to predict the next crisis situation, investors are now paying particular attention to the growing risks in the commercial real estate market and their possible reflection on the banking system and the broader economy. Rising interest rates, a slowing economy and increasing vacancies in office buildings have impacted the sector in recent years. A credit crunch is now expected amid rising funding costs for banks, which can only exacerbate its problems. However, in our view, while risks in commercial real estate have indeed increased, they do not pose a broad systemic threat.

The problems piling up for commercial real estate

One of''A derivative effect of the recent banking strains that the market has noticed is the demand for availability and cost of financing for commercial real estate loans. A growing share of commercial real estate loans from banks have been serviced by regional and local banks in recent years, and this now stands at about 70%. Given the recent collapses of SAVB and SBNY, which had a significant share of commercial real estate loans in their total loan portfolio, the market has begun to fear that regulatory action against these banks will become more stringent, resulting in restricted access to credit.

At the same time, the banks' problems are only adding to worries about the recent downturn in commercial real estate values at''against a backdrop of rapidly rising interest rates. Investors are increasingly focused on the total amount of commercial real estate debt outstanding and how to refinance it. Total commercial real estate debt is approximately $5.4 trillion, and the amount of debt due in 2023 and 2024 is $1.2 trillion (excluding residential complex real estate). High financing costs only exacerbate existing debt service problems, especially in office space and certain retail segments where cash flow has become difficult due to post-pandemic behavior.

Although pressures are mounting, headlines are worse than reality

Questions o'. 'refinancing at higher rates is important to consider in the context of the scale of the problem. It should be noted that the office space segment, which, as mentioned, is one of the most distressed sectors of commercial real estate, represents only 15% of the total value of commercial real estate.

Big name companies are still a concern for investors - even giants like Blackstone, PIMCO, Brookfield, and Simon Properties are in the news for high-profile defaults on commercial real estate. However, it's important to remember that even giant financial companies sometimes face inefficient investments. In such cases, the more financially prudent solution is to attempt to restructure the loan or return the keys to the lender. While such cases certainly attract media attention, they are not''representatives of systemic problems.

A liquidity crisis similar to 2008 is unlikely

While we do not downplay the current problems in commercial real estate, we emphasize that we do not believe a repeat of the 2008 liquidity crisis, when capital markets effectively closed for funding, is likely. In our view, the health of the banking system as a whole and liquidity conditions in the market have improved significantly compared to the period of the global financial crisis. Capital in the investment grade and higher-risk bond market, as well as in the preferred securities market, remains available; investment companies in the commercial real estate market continue to make unsecured loans; lines of''manageable

Although default rates are likely to increase, access to capital will become more restricted and credit conditions will become more stringent in the near term, we believe commercial real estate risks for banks are currently manageable and losses, even in the event of a severe downturn, are likely to cause earnings pressure rather than capital depletion. We do not believe that losses in banks' portfolios will increase to levels seen in the 2008-2009 period, when high losses on construction and land loans were driven by the housing and mortgage market crisis.

In general, a more severe economic drag between 2023 and 2024 could accelerate credit problems that would otherwise be avoided''or stretched over a longer period, which could put pressure on banks' earnings growth and profitability. Nevertheless, the magnitude of potential losses remains manageable, and we expect a significant deterioration in the commercial real estate market or its sub-segments, such as commercial offices, to put pressure on bank stocks, both because of the risk of lower profits and yields and increased concerns about the potential spread of the crisis to other types of assets.