Sharp reductions in value for office buildings have many waiting for a major collapse in commercial real estate (CRE), which in turn would damage city and state budgets and possibly threaten major bank failures. Thus far, borrowers and lenders have avoided the worst damage. But their delaying tactics may be coming to an end, with potentially dire consequences.

The fears were articulated amplified by economic analyses from NYU’s Arpit Gupta and Columbia University’s Stijn Van Nieuwerburgh. Their 2022 research predicted a “$664.1 billion value destruction” in U.S. office real estate.

Since then, they and other economists, along with market watchers, have predicted major losses in office values—a “deluge of debt,” a “severe crash,” a “$1.5 trillion crisis,” and other dire predictions.

Although commercial real estate values have taken a serious hit, we haven’t yet seen the predicted meltdown or “apocalypse.” As I wrote in Forbes in September 2022, “we are not in a commercial real estate apocalypse yet, but we all need to keep one eye on the danger.”

The lack of a total meltdown led some to argue that fears were overblown. There would surely be pain as banks had to restructure their loans, with second-class offices facing the biggest hit. But some analysts discounted the potential for deep harm.

In April 2023, CNBC’s Tim Mullaney published a thoughtful analysis of “the coming commercial real estate crash that may never happen.” He emphasized that many lenders seemed to be weathering the storm, with tenants continuing to pay rent and banks not defaulting on CRE loans.

In June, the Washington Post’s Natasha Sarin wrote “Why the commercial real estate crisis may not be as bad as you think.” She noted the CRE sector is bigger than offices (including apartments and warehouses, both doing well), and endorsed bank lenders “bolstering capital levels to safeguard against potential losses…before it’s too late.”

Now, in 2024, we are seeing a resurgence of fears about commercial real estate. Gillian Tett, in an excellent Financial Times column, notes that “little pain has been crystallised so far” in the sector. But she argues the bills are still coming due, and “it’s time to be honest” about the sector’s problems.

Unlike housing, where loans often are for 30 years, CRE loans usually have shorter maturities (ten years or less) , and need to be entirely refinanced when they come due. Many commercial loans were made during the recent period of historically low interest rates, so they now face a double whammy—falling asset values due to declining demand for office space, and significantly higher interest rates when refinancing.

At the same time, banks don’t want to declare loans as nonperforming, because that hurts their balance sheets. So there has been refinancing or restructuring on more favorable terms than some anticipated and perhaps more than the underlying economics justify—what some observers sarcastically call “extend and pretend.”

Tett cites a sobering analysis last year from Newmark Group, a major real estate advisory firm. Newmark saw a particular problem in CRE lending, with an overconcentration among small and regional banks, which tend to hold more CRE loans and also often are less well capitalized than the larger money center banks.

More recent data also indicate ongoing CRE problems. CommercialEdge monitors rent demand and prices for office space, and they recently found average office rents fell 1.2% year over year. That’s not an impossibly bad number, but when coupled with falling asset values for office properties with less demand, and facing higher interest rates, it isn’t a pretty picture.

CommercialEdge also reports on sales of office buildings, and finds that “discounted office sales have become more prevalent.” And of course, there are sharp regional variations. Commercial rents in the Boston market shot up by 21.5% year-over-year, while rates in Chicago and Seattle fell by over 2%.

This reflects vacancy rates. Boston’s vacancy rate is listed at 12.2%, compared to a national rate of 17.9%. There are higher vacancies in tech-heavy cities like Seattle (22.5%) and San Francisco (24%) as firms there adopt more remote work-friendly policies.

A new research note from Goldman Sachs underscores the depth of the problem. Modifications and extensions of CRE loans—“extend and pretend”—mean more loans will come due in 2024. Investopedia reports CRE loans maturing “by the end of 2024” are “up 41% from a year ago.” The Goldman research note concludes that “office mortgages are living on borrowed time.”

So the warning lights for office loans are flashing red. There will be major opportunities for buyers to snap up buildings, especially second and third-class space, at highly discounted prices. But there simply may be too much office space, especially in some troubled markets, to be absorbed, especially if banks are reluctant to lend.

There are troubling implications for the overall finance sector, and for city and state governments that depend on property taxes and economic activity generated by offices. My next blog will take a closer look at those two risks. But we may be coming to an end for CRE’s “extend and pretend” strategy, with gloomy economic consequences.

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