Rising CRE Loan Delinquencies: What It Means for Banks and the Real Estate Market

By Josh Eboh

A worrying trend has been emerging in the commercial real estate (CRE) market in recent months. According to S&P Global Market Intelligence data, the delinquency ratio for CRE loans across banks rose by 16 basis points in the second quarter of 2024. Even more concerning, this marks the seventh consecutive quarter of rising delinquencies. This isn’t just a blip on the radar—it’s a growing issue that could have profound ripple effects throughout the financial system and the broader economy, underlining the gravity of the situation.

But what does this mean for the average person? And why should we care about these rising delinquencies? Let’s break it down.

Understanding CRE Loan Delinquencies

When we talk about a “delinquency ratio,” we’re referring to the percentage of loans overdue or in default. In this case, it’s specific to loans in the commercial real estate sector—think office buildings, retail spaces, warehouses, and more. When property owners can’t make their loan payments on time, those loans are classified as delinquent. If too many of these loans go bad, it spells trouble for the banks that issued them and the owners trying to manage their properties.

A 16-basis-point increase might not sound like much, but it’s part of a more significant trend that has been growing for nearly two years. That steady rise shows that this isn’t just a temporary bump in the road; it’s a sign of more profound challenges in the CRE market.

Why Are Delinquencies Rising?

There are several reasons for this steady increase. First, higher interest rates are putting pressure on property owners. Many CRE loans have variable interest rates, meaning payments increase when rates rise. This has made it harder for owners to keep up with their loan obligations, especially for properties like office buildings and retail spaces, which have struggled since the pandemic.

Think of it like this: If you had a mortgage on your home and suddenly your monthly payments went up, you might feel the squeeze. Now, imagine you’re not just paying for a house but for a large commercial property that might not generate the expected income. That’s the situation many commercial property owners find themselves in today.

Second, the shift in demand for certain types of properties is also playing a role. For example, office buildings are still facing challenges as companies continue to embrace remote work or hybrid models. The demand for large office spaces has declined, making it harder for owners to fill those buildings, affecting their ability to repay loans.

Similarly, retail properties are feeling the impact of e-commerce. As more people shop online, demand for traditional retail space has decreased, leaving some malls and storefronts empty and struggling to stay profitable.

What Does This Mean for the Average Person?

At first glance, it might seem like rising CRE delinquencies only affect banks and big-time property owners, but the reality is more complex. Here are a few ways this trend could affect everyday people:

Tighter Lending Standards: As banks see more delinquencies, they will likely become more cautious with their lending. This means it could become more problematic for new businesses to get loans to open a store or develop a property. For instance, a local coffee shop hoping to expand might find it more challenging to secure financing, delaying or even preventing growth.

Changes in Property Values: Property values—especially for office and retail spaces- could drop if delinquencies keep rising. This could be a good thing if you’re a buyer looking for a deal, but it’s bad news for property owners who could see the value of their investments shrink.

Bank Stability: While we’re not on the verge of a financial crisis, banks with significant exposure to bad CRE loans might experience financial strain. For smaller community banks that serve local businesses, this could limit their ability to lend to small businesses or provide mortgages to homebuyers.

A Real-World Example

Imagine a developer who owns a large office building in downtown Charlotte. Several companies fully occupied the building pre-pandemic, and the developer could easily repay the loan. However, as the pandemic shifted work habits, many tenants either downsized or moved to remote work, leaving much of the building empty.

With fewer tenants paying rent, the developer needs help to make the loan payments significantly as interest rates have increased. This puts the developer at risk of defaulting on the loan, making it a delinquent asset for the bank that issued it.

Now, multiply this situation by hundreds or even thousands of office and retail properties across the country, and you start to see why rising CRE delinquencies are such a big deal for banks and the broader economy.

What Could Happen Next?

There are a few possible scenarios as this situation continues to unfold:

Tighter Lending: As banks worry more about delinquencies, they’ll likely tighten their lending standards. This means securing new loans could become more challenging for developers or businesses. For example, a developer wanting to build a new apartment complex might face higher interest rates or more stringent lending conditions, which could slow down construction and impact local economies.

Falling Property Values: If delinquencies keep rising, we could see a drop in the value of office and retail spaces. While this might present buying opportunities for investors, it could hurt current property owners who would see their investments lose value.

Increased Scrutiny from Regulators: With more loans going delinquent, regulators will likely closely monitor banks with large CRE loan portfolios. They might require banks to set aside more capital to cover potential losses, impacting their ability to lend in other areas.

Opportunities for Shift: While office and retail spaces struggle, other regions of CRE, like industrial real estate and multifamily housing, remain strong. Investors might shift their focus to these sectors, seeking stability and growth in a changing market.

In Conclusion

The rising delinquency rates in commercial real estate loans indicate that the market faces significant challenges. Higher interest rates, changing work habits, and the growth of e-commerce have all contributed to this trend, and banks, property owners, and developers will need to adapt.

For now, it’s crucial to monitor how these trends develop, as they have the potential to impact not just large financial institutions but also small businesses, property owners, and communities across the country. Small companies may find it harder to secure loans for expansion, and local communities could see a decline in property values and tax revenues.