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Uncertainty surrounding the direction of interest rates has been a major challenge for commercial real estate (CRE) trading momentum, according to Hessam Nadji, CEO of Marcus & Millichap, during an appearance on Yahoo! Finance.

Private individual investors, high-net-worth individuals, and small partnerships, who make up the majority of CRE ownership, are highly sensitive to interest rate changes. When the market anticipates lower interest rates, sellers tend to hold off, waiting for better values. Conversely, if rates are expected to rise, the opposite occurs, Nadji explained.

“It’s critical for the Federal Reserve to communicate clearly,” he said. “Looking forward, the market is starting to accept that we won’t return to the low levels seen in the previous cycle. While inflationary pressures are easing, they aren’t disappearing, so the Fed’s ability to aggressively lower rates will be limited.”

Commercial real estate values have decreased since peaking in March 2022, and many investors are now using cash to secure properties they’ve been eyeing, with plans to arrange financing when rates fall further, according to Nadji. He also emphasized the importance of the 10-year Treasury yield in driving CRE lending, noting that its recent rise to 4.5% has significantly influenced market sentiment.

“The optimism stems from corrected valuations, steady job growth that doesn’t challenge the Fed, and a combination of these factors alongside the scarcity of new supply,” Nadji added. “Building new developments is costly, so the supply side is in alignment with current market conditions.”

Turning to the potential effects of President-elect Trump’s proposed immigration policies, Nadji identified two key concerns. First, a large migrant population traditionally supports workforce housing rentals, so deportation efforts could negatively impact gateway markets and Class B and C apartment properties. Additionally, changes to immigration policy might affect the construction labor force in the U.S. However, Nadji suggested that the actual implementation of these policies might not match the aggressive scope outlined during the campaign.

Nadji also touched on the impact of tariffs on U.S. trading partners, which could influence supply chains and material costs, including lumber, for new construction.

Overall, while older, outdated office buildings continue to face challenges, Nadji highlighted that the retail and apartment sectors are performing well. Retail, in particular, is seeing a surge in optimism, with a two-decade high driven by the return of consumers to stores and digital brands creating physical showrooms.

“Retail is the industry’s current darling, and apartments are thriving,” said Nadji. “Homeownership affordability is at an all-time low compared to renting, leading to exceptionally strong demand for rental apartments.”

 

Source:  GlobeSt.

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You’ve managed to stay afloat through property challenges, avoided an immediate refinance, and waited things out. Then, the Federal Reserve made its third interest rate cut this fall, bringing hope that a little more relief might be on the way.

But recently, the Fed has signaled it will likely slow the pace and timing of rate cuts in 2025. This is unwelcome news for those seeking bridge or construction loans.

What does this mean for commercial real estate (CRE) mortgages? If T. Rowe Price Chief Investment Officer of Fixed-Income Arif Husain’s outlook holds, there may be more bad news ahead. In a recent report, Husain pointed out that U.S. fiscal expansion and potential tax cuts, coupled with a strong economy, are likely to push Treasury yields higher. He predicted that the 10-year yield could hit 5% by the first quarter of 2025, with the possibility of rising to 6%. This past Wednesday, the 10-year yield climbed to 4.5%, a level not seen since May 2024.

Rising 10-year yields signal greater risk-free long-term returns, which will likely lead lenders to increase CRE mortgage rates.

Husain identified six factors contributing to higher rates, but overall, he believes four of them will outweigh the other two.

The first four factors supporting higher rates are:

  1. U.S. fiscal expansion: With a budget equaling 7% of GDP and the Trump administration pushing for tax cuts, reducing the deficit seems nearly impossible. This will force the Treasury Department to issue large volumes of debt, which, when combined with similar actions by other countries, will flood the market. The increased supply of bonds will create pricing competition, and as bond prices drop, yields will rise.
  2. Decreased foreign interest in Treasurys: Countries like China and Japan have been reducing their holdings, leading to diminished demand. This reduced demand, alongside the increased supply of bonds, will lower bond prices and drive yields higher.
  3. A healthy U.S. economy: There is little indication of an imminent recession, meaning the economy is unlikely to cool down enough to reduce yields.
  4. Potential for inflation: While the Fed expects inflation to cool to 2% by 2027, tax cuts could inject too much capital into the system, raising prices. Additionally, tariffs could have a regressive effect, making goods more expensive.

However, there are two factors that could temper this outlook:

  1. Fed bank regulation guidance: New regulations could boost demand for Treasurys by banks, which might absorb some of the slack in demand, supporting prices and controlling yields.
  2. Political uncertainty and Fed actions: The political landscape has cleared with the upcoming election, and there are concerns about the Fed becoming less independent. This could encourage the central bank to slow or even stop quantitative tightening, potentially restarting bond purchases.

Despite these counterarguments, Husain concludes that longer-term Treasury yields are likely to rise, steepening the yield curve as the economic and fiscal conditions continue to evolve.

 

Source:  GlobeSt.

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As 2024 draws to a close, the mood in the commercial real estate (CRE) market has shifted toward optimism, fueled by favorable macroeconomic trends, supportive financial policies, and signs that a new growth cycle is underway, according to Crexi’s Q3 National Commercial Real Estate Report.

“Our industry is incredibly resilient, and sentiment has improved over the past quarter, despite some ongoing challenges,” said Eli Randel, chief operating officer of Crexi. “Market sentiment is as influential as the numbers themselves, and we’re optimistic about an even stronger 2025.”

The Federal Reserve’s interest rate cuts are expected to have a significant impact on the CRE sector, particularly by reducing borrowing costs, stimulating refinancing activity, and encouraging new investments. While economic uncertainty persists, Crexi notes that signs suggest the market has reached its bottom, with early indications of growth in CRE. Along with strong buyer engagement on its auction platform, the firm reports that bid-ask spreads have narrowed since the second quarter, marketing periods have shortened, and capital raising efforts are beginning to recover.

In Q3, overall buying activity increased across all asset types, with industrial rising by 5.5%, office by 5.93%, retail by 4.87%, and multifamily by 4.97%. Offers for properties also saw an uptick, signaling that serious buyers are making moves. On the leasing side, tenant activity showed a slight decline across most sectors, with industrial tenant activity experiencing the largest drop.

Key highlights from Crexi’s report include:

  • The median annual asking rent per square foot for industrial properties remained stable at $13.20 from Q2 to Q3 2024. However, the median annual effective rent per square foot rose from $9.50 to $12, suggesting a possible reduction in leasing incentives, which reflects landlord confidence in the industrial sector.
  • Office tenant activity indicators fell by 2.63% quarter-over-quarter but saw a 1.59% year-over-year increase. This annual rise may indicate that companies are reassessing their space needs, balancing remote work with in-person collaboration as the value of office presence becomes clearer.
  • The median annual asking price per square foot for retail properties saw a slight decrease, dropping from $282.60 in Q2 2024 to $287.37 in Q3 2024. This could be attributed to minor market adjustments, even as retail demand remains strong.
  • Multifamily median annual asking prices remained steady at about $170 per square foot, while the median closed price per square foot increased from $208.17 to $212.71, suggesting strong buyer demand is driving sale prices higher despite sellers holding firm on their pricing.

“Fundamentals remain relatively solid, with supply for most property types largely under control,” said Randel. “However, certain markets and property types may be slow to recover, or may not recover at all. As more favorable pricing emerges, there could be an increase in distressed transactions, providing an opportunity to clean up balance sheets and offload troubled assets.”

Crexi also notes that approximately $2 trillion in CRE loans are set to mature over the next two years, with office properties accounting for nearly one-third of this maturing debt, followed by multifamily, retail, and industrial assets.

 

Source: GlobeSt.

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Anticipation is building as the Federal Reserve’s Federal Open Market Committee prepares for a potential interest rate cut. According to CME FedWatch’s 30-day fed funds futures pricing, there is a 69% chance of a 25-basis-point reduction and a 31% probability of a 50-basis-point cut.

Despite hopes that rate cuts might ease the refinancing pressures faced by many in commercial real estate (CRE), the actual impact remains uncertain.

Any rate cut is expected to be modest. FedWatch indicates a 77.5% chance of a total reduction between 100 and 125 basis points by the Federal Reserve’s December 12, 2024 meeting. Whether this will be sufficient relief depends partly on lenders’ decisions regarding their spread. According to Clark Finney, Vice President and Director at Matthews Real Estate Investment Services, the effects on asset values are complex and not easily predictable.

Lenders may not fully align with the Fed’s rate changes, especially if Treasury indexes are used for pricing coupons. Finney points out that CRE deals often anticipate rate changes well in advance. For example, the 10-year Treasury yield fell from 4.09% at the end of July to 3.65% by September 10.

A swift return to ultra-low rates is unlikely, as the current economic conditions are not as severe as those during the Global Financial Crisis or the COVID-19 pandemic, which led to rapid rate cuts.

Even if borrowing rates decrease promptly—though this is not guaranteed—cap rates usually take six to nine months to adjust. This lag provides investors an opportunity to act before the broader market fully absorbs the Fed’s actions. For instance, an investor might find a property with a 6.5% cap rate while financing costs are at 5.5%.

Ryan Severino, Chief Economist and Head of US Research at BGO, told GlobeSt.com that the short-term outlook for CRE equity involves a gradual increase in investment volumes and valuations. Cap rates are expected to compress more significantly, and total returns should improve as both short- and long-term yields decrease.

Regarding the short-term credit market, Severino anticipates a gradual rise in debt origination volumes as borrowing costs decline. However, loan performance will vary by property type, with offices facing ongoing structural challenges and multifamily properties dealing with issues related to variable-rate debt that has been affected by rising interest rates.

 

Source:  GlobeSt.

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Commercial real estate debt delinquency rates continue to rise with the office sector playing a particularly strong role as its constituents work through bank portfolios, says S&P Global.

The overall delinquency ratio for those loans increased quarter-over-quarter 16-basis points to 1.450%. That came from higher interest rates making refinances more difficult to obtain. The problems are concentrated in the office sector, according to this S&P analysis. However, the firm did say that there is a “sharp decline in medium-term interest rates as Federal Reserve cuts near stands to provide some relief.”

Absent some disastrous surprise in inflation or the labor market, the Fed has already signaled that it will start cutting rates this month. But a sharp decline in any interest rates is far less in focus. Chances are that the September cut to the federal funds rate — the range at which depository institutions will lend to one another overnight without collateral — will be 25 basis points. It might go as high as 50 basis points, but that seems less likely.

When the Fed is done cutting, the total will probably be between 100 and 200 basis points, or somewhere between 3% and 4%. That would be much higher than the relative peak of 2.42% in April 2019. S&P Global recently noted,maturing mortgage rates have been on average 4.3%. Add whatever spread will be in fashion, and some sources have speculated that lenders will trend toward the broader after recent experiences in being caught by inflation — and it may be that wherever Fed rates eventually land, the prevailing CRE interest rates may not be that much more attractive than today.

In conjunction with this, S&P Global noted that the year-over-year growth of bank CRE lending was 2.9% in the first quarter of 2024 and 2.2% in the second quarter. In the third quarter of 2022, it was 12.1%. This shows how much depository institutions have pulled back as well as the degree to which property values have fallen, as the growth in lending is measured in dollars, not in property counts.

The number of banks that exceed 2006 CRE loan concentration guidance has been falling, from 577 in the first quarter of 2023 to 482 in 2024 Q4. The 20 banks with the largest CRE portfolios saw CRE loan totals dropping by a median of 2.1% year over year. There were declines in 12 of them.

It’s been a week of difficult news about long-anticipated waves of CRE mortgage maturities.JLL estimated $1.5 trillion in maturing debt by the end of 2025, roughly 25% of which faces refinancing challenges. About 40% of those properties needing refinancing are multifamily units, meaning that a focus on office as the risky area may not address enough. S&P Global has forecast maturity waves a few yearsout: $946 billion in 2024, $998 billion in 2025, $1.148 trillion in 2026, $1.257 trillion in 2027, and $1.138 trillion in 2028.

While the concept of a maturity wall has been a topic for discussion, it is moving toward a point of practical implications. Such growing pressures mean there is only so long that borrowers can outlast financing costs they can’t afford, and lenders can delay dealing with defaults.

 

Source:  GlobeSt.

 

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Pressure has been building over inflation expectations. When will the Federal Reserve cut interest rates? How long before CRE could return to, if not to a zero-rate policy, then closer to the pre-pandemic situation?

But another storm is on the horizon, one that some have been warning about although they’ve been largely ignored. The issue is the level of government debt, which is up to almost $34.6 trillion according to the non-partisan nonprofit Peter G. Peterson Foundation. The reason is structural factors, such as a large aging segment of the population, rising healthcare costs, and government spending that doesn’t bring in enough taxes to pay for what Congress authorizes.

Deficit spending requires more borrowing through government debt instruments as Reuters reports.

“Investors are bracing for a flood of U.S. government debt issuance that over time could dwarf an expected rally in bonds, as they see no end in sight for large fiscal deficits ahead of this year’s presidential election,” they wrote.

The mechanism that worries them is straightforward. There are three methods the U.S. government can use to obtain revenue to pay for its obligations. One is through taxes, but the amount brought in isn’t close to what is needed. The second is by printing money, which would eventually generate inflation. Third is borrowing, the approach the U.S. has used for generations.

Borrowing dynamics follow basic economics keeping one dynamic in mind — bond prices and bond yields move inversely. The more demand there is from those who want to lend the U.S. money by buying bonds, the lower the yield the government has to offer. The more debt the government wants to sell — that is, the more supply— the higher yields need to be to attract buyers. Also, the more the U.S. presents as a risky borrower, the greater the yield lenders/buyers will demand, and the more the government has to borrow, the riskier it seems.

Benchmark 10-year Treasury yields, now at around 4.4%, could go up to 8%-10% over the next several years, Ella Hoxha, head of fixed income at Newton Investment Management, who favors short-term maturities in Treasurys, told Reuters. “Longer term, it’s not sustainable.”

Meanwhile in some quarters concerns are reaching nightmare proportions. Jeffrey Gundlach, the CEO of investment management company DoubleLine Capital, is afraid the growing debt burden of the US government could eventually lead to a restructuring of US government debt, which would be unprecedented.

The world would likely see debt restructuring as an admission of problems and greater risk, increasing yields even more.

The bottom line for CRE: higher yields on the 10-year and SOFR — and both are strongly correlated and baselines of loan rates — would force real estate borrowing rates up.

 

Source:  GlobeSt.

 

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The Federal Reserve usually speaks as one. But it’s a big organization with many individuals, including those with their own reputations and areas of responsibility. And some have been coming out to question how many, or if any, interest rate cuts will be on the table for 2024 at all.

Neel Kashkari, president and CEO of the Federal Reserve Bank of Minneapolis, is the most recent voice wondering what degree of cuts might be possible. He wrote about the multiple factors that were making any prediction difficult. Disinflation has “stalled,” underlying economic demand has remained strong, and monetary policy is “much tighter” than before the pandemic.

In a discussion at the 2024 Milken Institute Global Conference in Los Angeles, California, replying to questions from New York Times’ economic reporter Jeanna Smialek, he said, “Inflation seems to have gone sideways while economic growth has remained resilient. It’s led me to question is monetary policy having as much downward pressure on demand as I would have otherwise expected.”

He pointed to the housing market, which has remained “remarkably resilient” given 30-year mortgage rates up to about 7.5%. He acknowledged questions about whether the so-called neutral interest rate — the short-term interest rate when the country sees full employment and stable inflation — might be higher than what the Fed has expected. It’s a point that Vanguard has raised.

If the neutral rate was higher than Fed estimates, “Instead of two feet down on the brakes, maybe only one, or possibly not much at all,” Kashkari said.

There are multiple scenarios he offered going forward, “the most likely” being that “we stay put for an extended period of time, until we get clarity on is disinflation in fact continuing, or has it, in fact, stalled out.”

If disinflation starts again or the country sees “marked weakening in the labor market,” there might be interest rate cuts this year, Kashkari said. “Or if we got convinced eventually that inflation is embedded or entrenched now at 3% and that we need to go higher, we would do that if we needed to.” “That’s not my most likely scenario, but I can’t rule it out.

Back in January, Christopher Walker, a Fed governor, notedthat economic news at the time was good.

“But will it last?” Walker asked. “Time will tell whether inflation can be sustained on its recent path and allow us to conclude that we have achieved the FOMC’s price-stability goal. Time will tell if this can happen while the labor market still performs above expectations. The data we have received the last few months is allowing the Committee to consider cutting the policy rate in 2024. However, concerns about the sustainability of these data trends requires changes in the path of policy to be carefully calibrated and not rushed.”

 

Source:  GlobeSt.

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The pressure that banks are feeling from CRE loans has become a regular observation by the Federal Reserve, Department of the Treasury, Federal Deposit Insurance Corporation, other regulators, economics, financial analysis, investors … pretty much everyone paying attention.

But there’s an odd twist according to a new analysis by economist and economic policy advisor Miguel Faria e Castro and senior research associate Samuel Jordan-Wood at the Federal Reserve Bank of St. Louis.

“Given the negative outlook on certain segments of CRE, one would expect that more-exposed banks have experienced worse market performances,” the two wrote. “We found that while CRE exposure has not mattered much for bank stock returns since the 2007-09 financial crisis, the correlation became significantly negative in 2023.”

The analysis started with an examination of the relationship between commercial real estate exposure as a share of total assets on one hand and total assets in billions of dollars, on a natural logarithm scale. Something immediately obvious is that the largest banks have a relatively small exposure in CRE loans as they represent 10% or less of their assets. But smaller to medium banks had high exposures, in some cases topping 60%.

They found that those banks with high exposure to CRE loans tended to have “relatively fewer liquid assets on their balance sheets, lower capital ratios (that is, more leverage), a larger share of their liabilities in the form of deposits, and a larger share of their assets in the form of loans.”

They then moved beyond a correlation analysis and used regression to look at the connection between CRE exposure and bank returns.

“From 2007 to 2008, the beta coefficient was statistically significant and negative, implying that banks with higher CRE exposure had lower stock market returns, all other variables equal,” they said. “Since the 2007-09 financial crisis affected not only residential real estate but also CRE, it is natural that more-exposed banks performed worse during that time. Our analysis reveals that while the correlation had been mostly inactive since then, it again became significantly negative in 2023.”

So, it seems to be another way banks are currently feeling negative effects from CRE exposure. Not just in concern over asset values and regulatory pressures, but in actual earnings.

 

Source:  GlobeSt.

 

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Wednesday’s Consumer Price Index numbers were higher than expected, sending Wall Street into a swoon about what it could mean.

For starters, it’s just about a given that, following this latest evidence that prices are not declining as fast as had been expected, the Fed will delay implementing its promised rate cuts. But some prominent voices are wondering about a worse case scenario: that the Fed might actually start raising rates. If this were to come to pass, simply put it would raise havoc in commercial real estate. GlobeSt.com has heard repeatedly over the last few months that transactions were resuming in part because the market believed that the Fed was done raising rates, introducing some much-needed certainty into forecasts.

Former Treasury Secretary Lawrence Summers is one of these voices.

“You have to take seriously the possibility that the next rate move will be upwards rather than downwards,” Summers said on Bloomberg Television. He said such a likelihood is somewhere in the 15% to 25% range.

The odds still do favor a Fed rate cut this year, “but not as much as is priced into markets,” he said.

Also, Federal Reserve Governor Michelle Bowman said earlier this month that it’s possible interest rates may have to move higher to control inflation.

“While it is not my baseline outlook, I continue to see the risk that at a future meeting we may need to increase the policy rate further should progress on inflation stall or even reverse,” she said in a recent speech to the Shadow Open Market Committee in New York.  “Reducing our policy rate too soon or too quickly could result in a rebound in inflation, requiring further future policy rate increases to return inflation to 2 percent over the longer run.”

Bowman is a permanent voting member of the Federal Open Market Committee.

JPMorgan Chase CEO Jamie Dimon has also floated the possibility that rates could increase in his letter to shareholders. The investment bank is  preparing “for a very broad range of interest rates, from 2% to 8% or even more,” he wrote.

These voices, though, are in the minority. Right now, most analysts have coalesced around the theory that rate cuts will be delayed this year.

Less than 24 hours after the CPI was released, Wall Street economists began revising their outlooks. Goldman Sachs and UBS now see two cuts starting in July and September, respectively, while analysts at Barclays anticipate just one reduction, in September, according to the Wall Street Journal.

Others are even more pessimistic about the timing.

“The lack of moderation in inflation will undermine Fed officials’ confidence that inflation is on a sustainable course back to 2% and likely delays rate cuts to September at the earliest and could push off rate reductions to next year,” Kathy Bostjancic, chief economist at Nationwide, said in a research note that was reported by The Associated Press.

Right now the Fed’s official expectation is that inflation continues to move down albeit in an uneven trajectory. If this is true, then rate cuts are still likely this year.

However, Wall Street worries that inflation has stalled at a level closer to 3% and if the evidence bears this out in future reports, it is conceivable that the Fed could scrap cuts altogether.

One indicator that does not bode well for rate cuts this year is the so-called supercore inflation reading, which besides excluding the volatile food and energy prices that the core CPI does, also strips out shelter and rent costs from its services reading.

Supercore accelerated to a 4.8% pace year over year in March, the highest in 11 months, according to CNBC.

Tom Fitzpatrick, managing director of global market insights at R.J. O’Brien & Associates, told the publication that if you take the readings of the last three months and annualize them, the supercore inflation rate is more than 8%.

All this said, the Fed has promised it would cut rates three times this year and that is a hard promise to unwind. The upheaval a rate hike would cause would give the institution a black eye even worse than its promises a few years ago that the creeping inflation in the economy was transitory.

 

Source:  GlobeSt.

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According to Newmark, there is now a $2 trillion maturity wall of CRE loans facing banks over the next three years. A dizzying sum.

But the statement raises a question. When the size of the oncoming wall — or wave or lava flow, or whatever to call the coming flood — is mentioned, is anyone really sure of the size?

CRED iQ’s database at middle of December 2023 showed “approximately $210 billion in commercial mortgages that are scheduled to mature in 2024, with an additional $111 billion of CRE debt maturing in 2025. In total, CRED iQ has aggregated and organized a total of $320 billion of commercial mortgages slated to mature within the next 24 months.”

In February 2024, the Mortgage Bankers Association said that 20% of commercial and multifamily mortgage balances were to mature this year.

“Twenty percent ($929 billion) of the $4.7 trillion of outstanding commercial mortgages held by lenders and investors will mature in 2024, a 28 percent increase from the $729 billion that matured in 2023, according to the Mortgage Bankers Association’s 2023 Commercial Real Estate Survey of Loan Maturity Volumes,” they wrote.

Even discussions can be misleading. Take the Financial Times article. The headline is, “Banks face $2tn of maturing US property debt over next 3 years.” The immediate question becomes how much of banks’ portfolios are coming due? But to get there, it’s critical to see what the total holdings are.

According to the Federal Reserve’s “Assets and Liabilities of Commercial Banks in the United States,” also known as H.8, thetotal of commercial real estate loans, including multifamily, held by banks was $2,985.5 billion during the week of March 20, 2024. Given the timelines of loans, most frequently five-year cycles, a 20% turnover annually is a realistic estimate. But a $2 trillion count would be two-thirds of all bank loans, which doesn’t seem plausible.

GlobeSt.com contacted Newmark for some clarity. The firm responded with information from David Bitner, Newmark’s executive managing director and global head of research. Here are his points:

  • “The $2T figure should indeed refer to ALL CRE loans (including 5+ unit multifamily).”
  • “Bank maturities are the largest share of near-term maturities, which is a large part of why we focus on them.”
  • “Debt fund and CMBS/CRE CLO debt is also front-loaded.”
  • “Data comes from Mortgage Bankers Association latest Loan Maturities report (released in mid-February).”

So, the pool of loans is much larger than those held only by banks. Even with the “extend and pretend” treatment lenders seeking to keep losses off their balance sheets, eventually reality sets in. In one sense, it won’t matter who holds the loans. As accounting standards eventually force lenders to write off clear losses, the result would be a large exercise in mark-to-market, lowering the value of many if not all CRE loans.

That would hurt the total asset values of many banks, which is the condition that led to the closures of Silicon Valley Bank, First Republic Bank, and Signature Bank last year. As Gosin told the FT, such a result would force some banks “to liquidate their loans or find other ways to reduce their weight in real estate,” whether by finding ways to increase capital, offload the risk, or further reduce the amount of CRE lending they do.

 

Source:  GlobeSt.