In several posts (most recently here), I have tried to assess the continuing risks associated with what has been called The Banking Crisis of 2023. In my view, the risks continue, including in particular with respect to banks’ exposure to commercial real estate market. A May 28, 2024, paper by an economist at the Federal Reserve Bank of St. Louis entitled “Commercial Real Estate in Focus” (here) takes a detailed look at the current state of play in Commercial Real Estate (CRE) and examines the implications for banks and thrifts that hold CRE debt. Given the extent of the exposures of banks and thrifts to CRE debt, the author concludes, the CRE sector remains “a challenge for the banking system,” with significant concerns for the banks “if and when losses materialize.”

As the paper details, the CRE asset market is a huge part of the U.S. economy, representing over $22.5 trillion as of the end of 2023. Outstanding CRE debt totaled $5.9 trillion as of the end of 2023, with banks and thrifts holding 50% of that total (government-sponsored entities, insurance companies, and debt securities make up the other half). With such a large share of CRE debt held by banks and thrifts, “the potential weaknesses and risks associated with this sector have become top of mind for banking supervisors.” 

It is worth noting, as the paper shows, that banks’ exposure to CRE debt has grown enormously in the past decade, growing from about $1.2 trillion outstanding as of the first quarter of 2014 to about $3 trillion at the end of 2023. It is perhaps even more noteworthy that, as the paper notes, “a disproportionate share of this growth has occurred at regional and community banks, with roughly two-thirds of all CRE loans held by banks with assets under $100 billion.”

In other words, the health of the CRE market is of critical importance for the banking industry. As the author details in her paper, the CRE sector is currently “navigating several challenges.” The first of these challenges arises from the fact that much of the outstanding CRE debt will soon be maturing and will need to be re-financed at higher interest rates. The second is that these interest rate risks arise while certain market fundamentals continue to deteriorate.

With respect to the maturing debt, the author notes that roughly $1.7 trillion, or nearly 30% of the outstanding CRE debt “is expected to mature from 2024 to 2026.” This prospect is known as the “maturity wall.” The CRE sector has long relied on shorter-term debt durations, in expectation that the debt will be re-financed at maturity. During the many years that interest rates were low and stable, this arrangement made sense. However, in the current interest rate environment, borrowers looking to refinance maturing CRE debt “may face higher debt payments.” While higher debt obligations by themselves weigh on profitability, the weakening of the CRE market’s underlying fundamentals, especially for the office sector, “compounds the issue.”

The three underling fundamentals that are, according to the author, deteriorating are: net operating income (NOI); vacancy rates; and valuations.

The net operating income for the CRE market “has come under pressure of late, especially for office properties.” The office sector faces “not only cyclical headwinds from higher interest rates by also structural challenges from a reduction in office footprints as increased hybrid and remote work has reduced demand for office space.” Higher expenses as a result of sustained economic inflation have also raised operating costs. Overall, the author points out, “any erosion in NOI will have important implications for valuations” (about which see below).

Vacancy rates are obviously important as well, as higher vacancy rates indicate lower tenant demand, “which weighs on rental income and valuations.” U.S. office vacancy rates in the first quarter of 2024 reached 19%, surpassing previous highs reached during the Great Recession and the COVID-19 recession. The vacancy rate may even underestimate the overall level of vacant office space, as space that is leased but not being fully used runs the risk of turning into vacancies as leases expire.

As rates remain elevated, NOI declines, and vacancy rates rise, CRE valuations are under pressure. Because there have been relatively few transactions through early 2024, “price discovery” remains a challenge –meaning it is hard to gauge exactly how much valuations have declined. The reason there have been fewer transactions recently is that “building owners have delayed sales to avoid realizing losses.” By one measure the author cites, the office sector commercial property price index as of the first quarter of 2024 had decline 34% from its peak. The author suggests that “further pressure on valuations could occur as sales volumes return.”

The author concludes that the CRE market remains “a potential headwind for the U.S. economy in 2024,” as weakening fundamentals suggest “lower valuations and potential losses.” Stress in the CRE market is likely to “remain a key risk factor to watch in the near term as loans mature, building appraisals and sales resume, and price discovery occurs,” which will “determine the extent of losses for the market.”


Some observers that follow the commercial real estate sector may say there is little new in the economist’s report, but I think the author deserves credit both for the concision of her summary and for marshaling key data to support her analysis and conclusions. The report, which is short, is worth reading in full.

The picture the author paints is indeed troubling. But notwithstanding the concerns, there are some things worth considering. For one thing, and for all of the gloom the author conjures up in her paper, there has still only been one failed bank so far in 2024, and here we are just weeks before the end of the year’s first half. To be sure, it could be that the real trouble is still ahead, as debts mature and as losses are realized. But in that regard, it is reassuring to note that, as the author observes, banks are now “increasing their allowances for loan losses on CRE portfolios,” and “stronger capital positions by U.S. banks provide added cushion against stress.” It is also probably worth noting that the author herself does not raise the specter of further possible bank failures ahead, but rather says only that there are key risk factors to watch in order to “determine the extent of losses for the market.”

There is one note in the author’s paper that is particularly troubling, and that is her observation that a “disproportionate share” of the growth in outstanding CRE debt during the past decade is concentrated at regional and community banks. The author specifically notes that CRE is a challenge to the banking sector overall, but that among banks with high CRE concentrations, “there is a potential for liquidity concerns and capital deterioration if and when losses materialize.”

The challenge that the CRE sector is facing is not helped by the fact that interest rate decreases, which many investors had assumed were on the calendar for later this year, likely will now be delayed. As long as interest rates remain elevated, the concerns surrounding the “maturity wall” will continue, with the likelihood that maturing debt will be rolled over at elevated interest rate levels – which will further weigh on landlords’ operating income and on valuations, which could contribute to and exacerbate losses.

One final note. All of these observations are disturbing enough by themselves, but they are even more alarming when the sheer size of the total CRE debt — $5.9 trillion — is taken into account, especially given that $1.7 trillion is due to mature during the 2024-2026 timeframe. That’s a lot of debt to roll over. It is also a lot of risk for creditors and lenders, particularly if interest rates continue to stay higher longer for longer.