Collapse? Why commercial real estate didn't go bankrupt ... yet

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It seemed obvious that the commercial real estate market was headed for a downturn. Building owners were struggling to fill space left empty after the introduction of telecommuting due to Covid-19. Some commercial builders who had taken out loans to finance projects were "just walking away, paying everything back to the lender," recalled Quincy Crosby, chief global strategist at LPL Financial.

The Federal Reserve's rate hikes to fight inflation beginning in March 2022 have increased the cost of credit. According to the National Association of Realtors (NAR), in the first''s quarter 2023 office vacancy rate reached a record 12.9%, up from 12% a year earlier. That same quarter, several banks collapsed, spooking the public; as a result, the Federal Reserve warned of a credit squeeze. Predictions of a recession in late 2023 have raised fears that companies will struggle with loan payments.

According to analyst reports, short sellers have been watching real estate investment trusts closely in recent months. So where is the crash? Analysts say the big drop in commercial real estate (CRE) values is likely to be a long downhill slide. "The decline in CRE is going to be staggered," says Crosby. Relating to banks' preference for extending nonperforming loans instead of their''s write-offs, she says, "It's the old strategy of '\''delay and pray'\'".

Office rents are still rising in many cities despite vacant space, a situation that varies greatly from city to city. According to a report by commercial real estate company JLL, office rents nationally rose 0.3% from the end of 2022 to the first quarter of this year. But rents are rising faster for more luxurious buildings in attractive locations, with some markets including Charlotte, Nashville and Orange County, California, seeing record deals, JLL said.

Financing for commercial real estate is also not a problem. As the Federal Reserve Bank of St. Louis points out, the volume of loans for''commercial real estate for May 2023 has reached an all-time high of $2.9 trillion, which has been tracked since 2004. In the last year alone, commercial real estate loans have grown by about 10%. Banks seem prepared to handle a possible economic downturn.

The recession is still expected, and office space is the most vulnerable. Despite a possible drop in commercial real estate, many observers still expect a downturn. CBRE, a commercial real estate and investment firm, predicts that the Federal Reserve's interest rate hikes aimed at curbing inflation will lead to a recession later in the year, which in turn will lead to a decline in real estate investment and leasing. "The decline will be gradual and uneven," CBRE says in its latest forecast. "The economy should stabilize by early 2024''year, but the effects of the downturn on real estate will continue until job growth resumes. "

Banks are already starting to write off delinquent commercial real estate loans. The level of charge-offs indicates the direction of the market, as it means borrowers can't keep up with loan repayments. According to CFRA Research, the delinquency rate was 0.95% in the first quarter of 2023, down from the pre-pandemic level of 1.01% in the first quarter of 2020, but "these rates are expected to worsen further in the second half of 2023 with a weaker U.S. economy," says Kenneth Leon, research director at CFRA Research, in a June 20 report. "The office space market has weakened since the pandemic. "

The Fate of Office Space''unclear in the face of new customers. After Covid, some employees are returning to the office, but hybrid and remote work remains. Companies like JPMorgan Chase are sending employees to work in the office, while others like Amazon and Apple require them to be in the office only part of the time. As a result, "the future of traditional office space is unclear," NAR says in an April 2023 report.

Therefore, property owners are looking for creative ways to repurpose their vacant office space. NAR notes that universities are showing interest in leasing office space to attract students back to classrooms. Some office buildings are being converted into apartments or studio apartments, although renovations are