After the banking crisis, could the next domino be all those empty office buildings in your downtown? Investors and economists are sounding the alarm about the commercial real estate market, seeing trouble ahead with refinancing. This sector has been hit hard for years now with the shift to remote work bringing about rising vacancy rates and falling property values. For her part, Lisa Shalett, the chief investment officer for Morgan Stanley Wealth Management, and strategists, sees a “huge hurdle” ahead.
“We fear stresses in other asset classes will become another headwind for megacap tech stocks alongside those posed by a profits recession and/or economic recession,” Shalett wrote in the weekly Global Investment Committee note. And she had some frightening figures.
“More than 50% of the $2.9 trillion in commercial mortgages will need to be renegotiated in the next 24 months when new lending rates are likely to be up by 350 to 450 basis points,” Shalett writes. Alarmingly, Shalett notes that regional banks accounted for 70% to 80% of all new loan originations in the past cycle, with all eyes on the sector after the historic implosions of Silicon Valley Bank and Signature Bank last month. She said office properties were already facing “secular headwinds” from remote work, and she now sees a wipeout with vacancy rates close to a 20-year high: “MS & Co. analysts forecast a peak-to-trough CRE price decline of as much as 40%, worse than in the Great Financial Crisis.”
As Fortune has previously reported, tighter lending standards for the commercial real estate market are now likely. In fact, stricter lending standards were already in place with the Federal Reserve raising interest rates in its attempt to lower inflation, and the banking crisis will only exacerbate the existing lack of liquidity. That in turn will increase the risk of defaults, distress, and delinquencies, as the industry is largely built on debt, experts previously told Fortune.
Distress on this scale, Shalett says, will hurt landlords and the bankers who lend to them, trickling down to business communities, private capital funders, and owners of underlying securities. Nor will the tech and consumer discretionary sectors be “immune,” she says.
And what of the wider impact on the economy? While Shalett sees a soft landing still possible, she says the odds of that happening are decreasing in light of the likelihood of tighter lending standards. None other than Twitter and Tesla CEO Elon Musk seems to share this view, having recently tweeted that the state of the commercial real estate debt market is “by far the most serious looming issue.” But of course, he’s got his own troubles with office buildings that could be fueling his concern.
