Current Conditions in the CRE Market

From testimony before the Joint Economic Committee by Jon D. Greenlee, Associate Director, Division of Banking Supervision and Regulation (here):  

Financial market dislocations and the continuing economic downturn are clearly challenging CRE markets. The pace of property sales has slowed dramatically since peaking in 2007, from quarterly sales of roughly $195 billion to about $20 billion in the first quarter of 2009. Demand for commercial property is sensitive to trends in the labor market, and, as job losses have accelerated, tenant demand for space has declined and vacancy rates have increased.

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The negative fundamentals in the commercial real estate property markets have broadly affected the credit performance of loans in banks’ portfolios and loans in commercial mortgage backed securities. At the end of the first quarter of 2009, there was approximately $3.5 trillion of outstanding debt associated with commercial real estate. Of this, $1.8 trillion was held on the books of banks, and an additional $900 billion represented collateral for CMBS. At the end of the first quarter, about seven percent of commercial real estate loans on banks’ books were considered delinquent.¹ This was almost double from the level a year earlier. The loan performance problems were the most striking for construction and land development loans, especially for those that finance residential development. Notably, a high proportion of small and medium-sized institutions continue to have sizable exposure to commercial real estate, including land development and construction loans, built up earlier this decade, with some having concentrations equal to several multiples of their capital.

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Reserve Banks with geographic areas suffering more acute price declines in real estate have been particularly focused on evaluating exposures arising from CRE lending. We have found, through horizontal reviews and other examination activities, that many institutions would benefit from additional and better stress testing, improved management information systems, and stronger appraisal practices, and that some banks need to improve their understanding of how concentrations–both single-name and sectoral/geographical concentrations–can impact capital levels during shocks.