The near-term outlook for commercial real estate (CRE) has become increasingly clouded due to rising interest rates and lingering fears of a recession. Banks today are facing a perfect storm as higher interest rates have resulted in tighter credit standards accompanied by regulators more closely monitoring the quality of CRE loans. A tighter lending market, along with declines in real estate investment trust (REIT) stocks, suggest yield expectations on CRE have repriced, and price declines and distress in certain asset classes are underway. If we are entering a distress cycle, it’s in the early days, as transaction volumes are down a near-record 70%, according to Green Street,¹ making price discovery more elusive. While today’s environment is more stable than the events that unfolded in the Great Recession of 2008, economic clouds are starting to gather on the horizon. So, how can real estate borrowers weather a potential storm? Preparing a defensive strategy and building resilience in a portfolio’s capital structure will be the keys to success.
During the recent webcast, “Distress in real estate: a roadmap for navigating uncertainty,” Mark Grinis, EY Americas Real Estate, Hospitality & Construction Sector Leader, led a panel that discussed the implications of the current real estate market on lenders, borrowers and investors. The panel consisted of CRE industry experts, including restructuring, banking, tax and law professionals.
According to an EY analysis, deal volume in the CRE market has declined in tandem with rising interest rates, with CRE trades down approximately 70% in first quarter 2023 relative to first quarter 2022 volumes. Capitalization rates across all asset classes are increasing, albeit at a slower pace relative to interest rates, according to EY research. As investors perceive greater risk in CRE, pricing has fallen, and it is expected to continue to fall for the year ahead.
Office at the center of the distress conversation
While distress to date has been concentrated in certain metro areas and asset classes, at the center of the webcast’s conversation was the risk unfolding in the office sector.