International Monetary Fund warns of US commercial real estate market

If you want a gauge of how dark the storm clouds are gathering over the U.S. commercial real estate market, look no further than recent warnings from the International Monetary Fund (IMF). In late January, the IMF published an article on monetary policy expressing deep concern about two specific threats to commercial real estate: rapid growth paired with declines in real estate values ​​and the impact of maturing debt.

The article noted that in the United States, which has the world's largest commercial real estate market, real estate values ​​have fallen 11% since the Federal Reserve began raising interest rates in 2022 to fight inflation. As financing costs rise, some decline in value is expected. This is because higher borrowing costs mean higher investment costs and lower value.

What particularly concerns the IMF about this situation is that the decline in real estate values ​​over the past few years has been much more severe than in similar past monetary tightening cycles by the Federal Reserve and other central banks. The IMF also believes that the rapid and sustained pace of recent austerity measures by the Federal Reserve may have contributed to the depth and speed of the decline in real estate prices.

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High vacancy rates, changing work culture and mountains of debt

Rising interest rates are hurting the value of U.S. commercial real estate, but financing costs aren't the only thing hurting the commercial sector. Office properties are most affected by economic conditions, primarily due to a combination of unforeseen circumstances. The COVID-19 crisis has dealt a devastating blow to the U.S. economy, forcing many businesses to permanently close their doors.

Many of the companies that survived adapted to the coronavirus by having many of their employees work remotely. Both of these factors have a significant impact on office vacancy rates, which are at an all-time high with a national average of approximately 19%. Annual revenue from rental income is one of the main metrics used to evaluate commercial real estate, and most buildings become unprofitable when the occupancy rate falls below 95%.

Average occupancy rates in the 80% range mean that the typical office building is not only not producing a profit for investors, but also not producing enough profit to pay off real estate debt. The IMF cited research from the American Mortgage Federation that shows the United States has $1.3 trillion in outstanding commercial mortgage debt due in 2024. Approximately 25% of this is concentrated in the office and retail sectors.

Exposure of small regional banks increases

The IMF is concerned that much of the commercial real estate debt in the United States is held in mortgage loans and commercial mortgage-backed securities from small regional banks. So far, there are no signs that a collapse like the 2008 residential mortgage crisis is imminent, but the warnings paint a grim and frightening picture about the future of U.S. commercial real estate.

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