There’s trouble ahead in the commercial real estate space—especially in the office sector, which has been plagued by the shift to remote work.
In the first quarter of this year, the commercial real estate loan delinquency rate increased by 12 basis points to 0.77%. That’s the highest it’s been since the third quarter of 2021, when it reached 0.83%, according to a new report published by S&P Global Market Intelligence. It’s a bigger deal than it might first appear.
“Investors come under increased scrutiny of loans tied to office buildings, and banks are exercising caution over CRE loans, which could increase stress on borrowers and pressure policymakers to intervene,” wrote S&P Global Market Intelligence researchers in their analysis titled: “CRE loan delinquency rate at US banks rises sharply.’
Heading forward, the commercial real estate loan delinquency rate is expected to rise further.
One reason being the stress in the banking sector: Following the failures of Silicon Valley Bank and Signature Bank, commercial real estate borrowers started to see credit tighten further, in the form of fewer loans and stricter lending standards. That, in turn, is expected to increase delinquencies and defaults.
As of March 31, total commercial real estate loans at U.S. banks increased by 0.5% to $2.436 trillion from $2.422 trillion at the end of last year. And only multifamily commercial real estate loans “edged lower,” analysts wrote. Multifamily loans were at $593.09 billion by the end of the quarter. To compare, construction and land development loans were at $479.69 billion.
Total nonowner-occupied nonresidential property loans hit $1.151 trillion, which account for nearly half of all commercial real estate loans, the authors wrote. Nonowner-occupied simply means the property owner does not occupy the property as their personal residence. Those loans, the authors wrote, have increased for the past three quarters, jumping 24 basis points in the last quarter alone.
Not to mention that the number of banks with commercial real estate exposure has also increased. Of those, 576 U.S. banks have “exceeded regulatory guidance on CRE loan concentration by the end of the first quarter, an increase of 30.3% compared with a year earlier,” the authors wrote. With that comes increased scrutiny from regulators, particularly among banks with construction loans with at least 100% of risk-based capital or commercial real estate loans with at least 300% of risk-based capital and 50% growth in the sector over the past three years, the authors note.
The authors of the S&P Global Market Intelligence analysis compiled a list of the 20 largest banks in the U.S. that have exceeded commercial real estate exposure guidance. As of the first quarter of this year, New Jersey-based Valley National Bank (with $64.31 billion in total assets) was the largest to “exceed CRE guidance.”
“Its CRE loan balance grew 77% in the 36 months ended March 31 and CRE loans represented 457.8% of tier 1 capital plus allowance for loan and lease losses,” the authors wrote, referring to Valley National Bank.
As Fortune’s recently reported, a “doom loop” could ensue between banks and the commercial real estate sector in a worst case scenario, which in some cases would look like fleeing depositors and an end to CRE loans. However, high CRE exposure isn’t always bad, especially if a bank’s office exposure is relatively low.