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Smaller banks reveal ripple effects of commercial real estate woes

Mitchell Hartman Apr 18, 2024
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Small, local banks might have up to 50% of their portfolios in CRE, says Suri Sharma of Morningstar. But some subsectors of the field, like industrial property, are strong. Andrew Caballero-Reynolds/AFP via Getty Images

Smaller banks reveal ripple effects of commercial real estate woes

Mitchell Hartman Apr 18, 2024
Heard on:
Small, local banks might have up to 50% of their portfolios in CRE, says Suri Sharma of Morningstar. But some subsectors of the field, like industrial property, are strong. Andrew Caballero-Reynolds/AFP via Getty Images
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Another raft of quarterly bank earnings came in over the last couple of days. Not for the biggest banks, mostly pretty big regional ones.

But the picture isn’t very pretty. High interest rates — likely to stay higher for longer, the Federal Reserve has warned — are hurting profits. On Thursday, KeyCorp, Comerica and Ally all reported that their net income fell. Wednesday it was a similar story from U.S. Bancorp and Citizens Financial.

One thing weighing on the sector is commercial real estate. These banks have a lot of CRE loans on their books, beset by the double whammy of high interest rates and high office vacancies from the pandemic-era shift to remote work.

More evidence of the trend from ATTOM, which tracks real estate data nationwide: Commercial property foreclosures were up more than 100% — 117%, to be exact — from March 2023 to March 2024. 

Commercial real estate includes four property types: industrial, retail, multifamily and office. And it’s clear which is the weakest link, said Suri Sharma at Morningstar. “The real stress is in offices. There’s absolutely no doubt about it,” he said.

How much stress?

“Commercial office space is in a significant recession. We’re testing the extreme declines in the Great Financial Crisis” of 2007 and 2008, said Susan Wachter, a real estate professor at the University of Pennsylvania’s Wharton School.

“This is a crisis,” she said. “But it’s a contained crisis and a slow-moving one. If we continue to have strong growth, without an interest rate spike and without a recession, the pain will be under control for the overall economy.”

But not for building owners, struggling with half-empty office towers and maybe not enough rent coming in to pay their bank loans. 

Morningstar’s Sharma said the biggest banks should be fine. But small, local banks might have 40% to 50% of their portfolios in commercial real estate. 

“So if things go bad, there is a very real chance some of these banks go down under,” he said.

Now, commercial real estate also includes industrial property, which Ken Simonson, chief economist at Associated General Contractors of America, said is on a tear.

“Very strong growth in data center and manufacturing plant, infrastructure, and there’s lots of renewable power projects, from solar to battery storage and maybe even some offshore wind,” he said.

As for retail, Sharma said it’s in pretty good shape. And, a huge wave of new multifamily apartment buildings is about to hit the market.  

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