The commercial real estate market is starting to buckle under the weight of higher interest rates and remote work.
There were 625 commercial real estate foreclosures in March, up 6% from February and 117% from the same time last year, according to a new report published by real estate data provider ATTOM.
The figure is calculated based on commercial properties with at least one foreclosure filing – including default notices, scheduled auctions and bank repossessions – entered into the ATTOM Data Warehouse during the month.
California had the highest number of commercial foreclosures in March, with 187 properties. While that marked an 8% decrease from the previous month, it is a stunning 405% jump from the previous year.
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“California began experiencing a notable rise in commercial foreclosures in November 2023, surpassing 100 cases and continuing to escalate thereafter,” the report said.
New York, Florida, Texas and New Jersey also saw notable increases in commercial foreclosures last month.
Foreclosures have steadily risen since May 2020, when they hit a record low of just 141 properties. At that time, the U.S. economy was still in the throes of the COVID-19 pandemic, and many lenders offered commercial loan forbearance to borrowers to help them stay afloat.
However, those agreements have largely expired and now, the commercial real estate market is struggling with a number of challenges, including higher interest rates and waning demand for office space as more companies allow employees to work from home.
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The Federal Reserve raised interest rates to the highest level since 2001 in response to sky-high inflation. Rates are poised to remain elevated for some time, as policymakers have signaled they are not prepared to start reducing rates until they are more confident that inflation has returned to 2%.
About $1.5 trillion in commercial mortgage debt is due by the end of 2025, but steeper borrowing costs, coupled with tighter credit conditions and a decline in property values brought on by remote work, have increased the risk of default.
Roughly $929 billion worth of commercial real estate loans are set to mature this year, according to the Mortgage Bankers Association. Borrowers may have no choice but to refinance with significantly higher interest rates or sell their properties at a steep loss.
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Complicating the matter is the fact that small and regional banks are the biggest source of credit for the $20 trillion commercial real estate market, holding about 80% of the sector’s outstanding debt. Regional banks were at the epicenter of the upheaval within the financial sector last year following the collapse of Silicon Valley Bank, and there are concerns that the turmoil could make lending standards drastically more restrictive.
During a credit crunch, banks significantly raise their lending standards, making it difficult for businesses or households to get loans. Borrowers may have to agree to more stringent terms like high interest rates as banks try to reduce the financial risk on their end.
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Fed Chair Jerome Powell said in March that commercial real estate woes will likely lead to some bank failures, but do not pose a larger threat to the financial system.
“We have identified the banks that have high commercial real estate concentrations, particularly office and retail and other ones that have been affected a lot,” Powell said while testifying on Capitol Hill. “This is a problem that we’ll be working on for years more, I’m sure. There will be bank failures, but not the big banks.”
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