International Monetary Fund Sounds Warning Over US Commercial Real Estate Market

If you want a barometer for how dark the storm clouds gathering over America's commercial real estate market are, look no further than a recent warning by the International Monetary Fund (IMF). In late January, the IMF posted an article on monetary policy expressing deep concern over the impact of two specific threats to commercial real estate: rapidly rising and maturing debt paired with declining property values.

The article pointed out that America, which has the largest commercial property market in the world, has seen property values decline by 11% since the Federal Reserve began raising interest rates in 2022 to combat inflation. Some degree of decline in value is to be expected when lending costs rise because higher borrowing costs mean investments cost more and appreciate less.

What specifically concerns the IMF about the situation is that the decline in property values over the last several years is much steeper than similar past cycles of money tightening by the Federal Reserve and other central banks. The IMF also believes the rapid and sustained pace of the most recent rounds of Federal Reserve belt-tightening may have translated to this extra degree of depth and speed to sliding property values.

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High Vacancy Rates, Changing Work Culture And A Mountain Of Debt

Rising interest rates have hurt U.S. commercial property value, but the cost of financing is hardly the only specter haunting the commercial sector. Office properties have the most exposure to the economic situation, and this is largely because of a combination of unforeseen circumstances. The COVID-19 crisis devastated the U.S. economy and caused many businesses to shut their doors permanently.

Many of the businesses that survived adapted to COVID by going to a remote work policy for much of their workforce. Both these factors had a major impact on office vacancy rates, which are averaging an all-time high of around 19% nationwide. Annual revenue from rental income is one of the main metrics used to value commercial real estate, and most buildings can't make money when occupancy falls below 95%.

An average occupancy rate in the 80% range means a typical office building is not only failing to make money for its investors, but it's also not making enough money to service the property debt. The IMF cites an American Mortgage Federation study showing that America has $1.3 trillion in outstanding commercial mortgage debt that will come due in 2024. Roughly 25% of that is concentrated in the office and retail sector.

Smaller Regional Banks Have Increased Exposure

The IMF is concerned that much of the debt on America's commercial real estate loans is held in mortgages from small, regional banks as well as commercial mortgage-backed securities. So far, it has not signaled that a collapse like the residential real estate loan crisis of 2008 is imminent, but its warning offers a sobering and frightening look at the future of U.S. commercial real estate.  

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