CRE performed strongly, but continued monitoring needed as trouble could still be ahead, report asserts

The commercial real estate (CRE) market has held strong so far, but trouble could be ahead for loan performance with even small changes in economic and financial conditions, a report from the Treasury’s financial analytics office said Tuesday.

According to the report issued by the Office of Financial Research (OFR), the CRE market “held strong” during the 2020 economic downturn resulting from the coronavirus crisis. The report also indicated that CRE performed strongly during the switch to remote work and away from centralized offices.

“However, relatively small changes in economic and financial conditions could have a detrimental impact on CRE loan performance,” the report stated.

According to the report, the changes that could affect CRE loan performance include: a sustained rise in inflation which could pressure CRE sectors subject to rapidly rising operating costs; CRE investors requiring a higher return (higher risk premiums) to hold CRE; and negative economic growth.

However, the OFR said it had analyzed a new emerging risk: a change in lessee preferences that could increase CRE vacancy rates, such as office lessees requiring less space as employee telework, reflecting the reality of current work schedules and office place norms.

“To date, CRE has posed little risk to the financial sector,” the OFR said in a blog post. “This is because the limited credit losses recognized so far have been easily absorbed. However, emerging risks could pressure the loan performance, causing issues for lenders and, if the severe, systemic financial risk for the U.S.”

The blog post noted that OFR’s analysis showed shows how the emerging risks to the CRE market “could have a detrimental impact on CRE loan performance leading, and thus continued monitoring of the future performance of CRE is important for financial stability.”

U.S. Commercial Real Estate Has Proven Resilient, but Emerging Risks Could Generate Losses for Lenders