These factors will “put a lot of stress on the owners of these properties,” Yellen said, speaking before the House Committee on Financial Services Tuesday.  She cited an increase in interest rates and the higher vacancy rates resulting from a shift to hybrid and remote work—as well as a swath of commercial real estate loans that will soon come due. 

About $325 billion of loan maturities are coming due, Kevin Fagan, Moody’s Analytics head of CRE economic analysis, told Fortune; and some loans will have trouble refinancing at higher interest rates, which will further slow commercial real estate demand. 

“The current vulnerability of CRE property performance is highly concentrated among office properties, particularly for those with near-term loan maturities and high lease rollover,” he said. 

Federal Reserve Chair Jerome Powell also expressed concern this week about the commercial real estate market—particularly its effects on the banking industry. “It feels like a problem we’ll be working on for years,” he told CBS in a 60 Minutes interview on Sunday, adding that “it’s a sizable problem,” albeit a “manageable one,” largely affecting small and regional banks.

Yellen agrees that regulators have the situation under control, but there is still cause for worry.

“I’m concerned,” she said. “I believe it’s manageable, although there may be some institutions that are quite stressed by this problem.”

The state of the commercial real estate market

The pandemic has left a number of commercial sectors transformed—and office space took the biggest blow. Co-working giant WeWork filed for bankruptcy, Wells Fargo let go of its 550,000-square-foot namesake tower in Raleigh, N.C., and innumerable institutions big and small continued to shed the office space they no longer needed. 

Indeed, as much as 330 million square feet of U.S. office space could become vacant by 2023, owing to remote and hybrid work, according to a 2023 report by global real estate firm Cushman & Wakefield. Plus, an additional 740 million square feet of office space will become vacant from “natural causes” by the turn of the decade, leaving about 1 billion square feet of unused office space total, the report predicted.

While high vacancy rates undoubtedly play a role in the boiling trouble with commercial real estate, they are only part of the picture.

“The story is less about commercial real estate value—although low occupancy rates in retail spaces and office buildings after COVID play a role—and much more about the financing that is in place,” Michael Imerman, an assistant professor at UC-Irvine’s Paul Merage School of Business who focuses on banking and risk management, told Fortune.

Many commercial developers and investors took out loans in the aftermath of the Global Financial Crisis when interest rates were low, Imerman said. Because these loans have 10- to 20-year maturities, they’ll be coming due soon. 

“With interest rates having increased so much over the past 18 months, the owners of these properties—the real estate developers and investors—will have to refinance at a much higher rate,” Imerman said. “Couple that with the low occupancy rates, [and] there is no way that these loans will be serviced, which is going to lead to a massive amount of commercial real estate loan delinquencies in the next few years.” 

The Fed and the Treasury say the problem is ‘manageable’

Speaking more specifically about failing banks, Powell has said that the “system could take losses” as a result of the commercial real estate market downfall. That was in June 2023, just a few months after the Federal Reserve took extraordinary measures to prevent banking contagion after the collapse of Silicon Valley Bank, then the second-largest in U.S. history.

Yellen also said that the Financial Stability Oversight Council closely monitored both commercial and residential real estate risks in 2023.

“When two regional banks failed last March, we acted quickly to prevent contagion to banks with similar vulnerabilities and to maintain confidence in the banking system,” she said in prepared remarks for this week’s Congressional hearing. “The Council also increased transparency this year, issuing an analytic framework that for the first time provides the public with in-depth information on how it monitors, assesses, and responds to potential financial risks.”

Yellen vowed that the Treasury would continue to watch the space closely. “Commercial real estate is an area that we’ve long been aware could create financial stability risks or losses in the banking system,” Yellen said. “This is something that requires careful supervisory attention.”