Bank failures could begin to percolate across the U.S. due the ongoing tumult in the commercial real estate sector, according to finance experts at Florida Atlantic University (FAU).
Dr. Rebel A. Cole, the Lynn Eminent Scholar Chaired Professor of Finance in FAU’s College of Business, highlighted fourth quarter 2023 data from bank regulatory agencies to detail the level of challenge. Cole’s analysis determined that among U.S. banks of any size, 1,522 out of 4,641 institutions have total commercial real estate exposures (amount of CRE relative to amount of equity capital) greater than 300%, while 732 have exposures greater than 400%; 320 have exposures greater than 500% and 113 have exposures greater than 600%.
“The demand for office space has fundamentally shifted downward,” said Cole. “During the pandemic, people began to work from home instead of heading into the office. Now, four years later, that is still the case. It’s a problem for the banking system as there are a lot of banks that have extensive exposure to risk.”
Complicating matters could be the Federal Reserve’s rate-making policies.
“Inflation hasn’t cooled as fast as the Fed has hoped, which should lead to a more hawkish Fed,” said Dr. Ken H. Johnson, real estate economist in FAU’s College of Business. “A less favorable rate environment combined with declining rents is affecting the value of commercial office space, worrying banks and bank regulators.”
However, Cole and Johnson have different forecasts on how severe this situation could become. Johnson predicted potential bank closures could be minimal and not heavily weigh on the banking system.
“There is a lot of investment capital looking to step in and buy shares, if you will, of these buildings due to the large amount of perceived equity,” Johnson said. “Banks have opportunities for deals to be worked out short of the owner simply turning over the keys to the building. The likelihood of a massive financial crisis similar to 16 years ago is very small.”
But Cole was less sanguine on the near-term future.
“This is a very serious development that won’t go away,” he said. “Higher mortgage rates affect all properties, including both commercial and residential mortgages. There’s growing concern that, with higher interest payments, these properties will no longer be cash flow positive. If owners walk away from these buildings, it creates a comparable sale at a huge discount, leading appraisers to mark down the value of other properties with positive cash flows.”
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