Joe Woolhead
US commercial real estate prices are enduring one of the sharpest drop-offs in the last half-century, easily topping losses seen in previous rate-hike cycles, the International Monetary Fund said.
Since the Federal Reserve's first interest rate hike in March 2022, US commercial property prices have slumped by over 11%, the agency outlined in a blog post. As the fed funds rate climbed from near-zero levels to a range of 5.25%-5.5%, property-price gains notched in the prior two years have completely disappeared.
While tighter monetary policy has often led to reduced demand and slumping values, the current rate of decline stands out, analysts led by Andrea Deghi wrote.
"As the Chart of the Week shows, contrary to the current policy cycle, commercial property prices remained generally stable or saw milder losses during past Fed rate hikes," they said. "Some of the earlier rate hikes, though, such as in 2004-06, were subsequently followed by a recession during which commercial property prices recorded notable declines as demand fell."
Today's trend most closely follows the trajectory of price declines recorded in 1983-1984 and 1988-1989, when values tumbled by 5.86% and 2.71%, according to the IMF's data.
International Monetary Fund
The magnitude of today's decline is partially due to the unusually sharp pace of tightening that's taken place during in the current cycle. Given how quickly the Fed raised interest, mortgage rates and commercial mortgage-backed securities yields also saw a sharp jump as a result of stress in the sector.
In the meantime, higher borrowing costs took a toll on private equity fundraising, a key source of financing for the sector as well. while stricter lending standards among banks only deepened the credit crunch.
"For example, about two-thirds of US banks recently reported a tightening in lending standards for commercial construction and land development loans, up from less than 5 percent early last year," the blog said.
To top it off, pandemic-era remote work and e-commerce trends are pulling down on office and retail sector demand, with these property types suffering the highest delinquency rates. The office market in particular is feeling the pain, as remote work appears to be a lasting legacy of the COVID era and has tamped down demand for space.
Although the Fed is expected to eventually start cutting rates this year, Wall Street has grown anxious that a wave of defaults will soon sweep through commercial real estate, especially with over a trillion in debt maturing within two years.
In one worst-case scenario, that could as much as $1 trillion in commercial real estate equity, according to Cantor Fitzgerald CEO Howard Lutnick.
"Financial supervisors must continue to be vigilant. Rising delinquencies and defaults in the sector could restrict lending and trigger a vicious cycle of tighter funding conditions, falling commercial property prices, and losses for financial intermediaries with adverse spillovers to the rest of the economy," the IMF cautioned.
