A commercial property bust in the U.S. will have significant consequences for the banking system and regional banks. It could also impact non-residential investments in the U.S. While the commercial property market is much smaller than the residential market, a commercial property bust could negatively impact U.S. banks, regional banking systems, and the economy at large. Here are yoursite.com why a commercial property bust is important for banks:
COVID-19 pandemic threatens
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The COVID-19 pandemic is threatening hard-won gains in health and education made over the past decade. This virus’ spread could cause a sudden recession and expose financial vulnerabilities that had been building during the low-interest rate environment. Leveraged investors could face margin calls and be forced to sell their portfolios. Financial deleveraging could further exacerbate the selling pressures.
Declining prices
The decline in prices of commercial property could cause massive losses for U.S. banks. As COVID-19 inactivity grows, it could starve businesses of capital and undermine financial stability. As in the previous two downturns, banks have failed after big losses in commercial real estate loans, including the great recession in 2008. A recent study by Oxford Economics indicates that U.S. banks have lost $110 billion in commercial real estate loans during the last financial crisis, roughly one-quarter of their total losses.
Recent reports have revealed that office rents in Singapore have declined 6% since last year’s peak. Despite rising vacancies, office rents could fall 20 to 35 percent. Hotels and retail properties have also been hit more heavily than other sectors. Banks have bolstered their capital positions by introducing regulatory changes in the wake of the 2008 financial crisis. But a decade of low interest rates has also led to financial risks that have accumulated.
Increased bad-loan write-offs
According to a report from Oxford Economics, increased bad-loan write-offs could lead to losses of 1% to 10% of banks’ tier one capital, which is their main funding source. The biggest impact would be felt in Asia, but bond investors in the U.S. are at risk, too. That’s because about half of non-bank lending is made through bonds. In recent years, the proportion of non-bank lending has increased to 25% or more.
The current commercial real estate bust has seen prices plunge. While this is not always a problem, it could potentially hit the commercial real estate market by reducing the demand for office space. Liberal work-from-home policies could also reduce demand for office space. In addition, the pandemic has been devastating for lodging and retail properties. COVID-19 cases jumped to alarming new records in November.
Impact on non-residential investment
As the economy continues to recover from the financial crisis, many companies are cutting back on capital spending. The impact on non-residential investment is expected to be pronounced in 2008, as will the corresponding drop in GDP. However, changes in fixed investment are closely correlated with GDP. In the figure below, the blue line represents the change in fixed investment over the past year and the red line represents GDP growth. The correlation is 79%.
The trend in office construction has been slowing for the last several years. Even as the population increased by 40 percent from 1980 to 2014, nonresidential construction did not. In the period from 1980 to 2014, real non-residential construction spending in the US totaled $441 billion. This is one of the few components of GDP that is highly cyclical. The US population is growing fast and nonresidential construction spending has lagged behind, with peaks of over $500 billion and troughs of $350 billion-400 billion.