Nearly a year into the pandemic, questions loom about the future of commercial real estate portfolios. How much longer can banks offer deferrals on loans that have soured during the pandemic recession, are foreclosures inevitable, and how quickly could foreclosure rates rise?
Bankers have had a mostly reassuring tone about their ability to manage the credit risk but will face these questions when big banks begin to report fourth-quarter results.
The 2021 U.S. Real Estate Market Outlook, compiled by CBRE Group, predicts that “real estate conditions will start 2021 in a state of flux” as some sectors “grow strongly” while others will keep struggling. The lack of clarity on asset pricing won’t help, CBRE Global Chief Economist Richard Barkham said.
“Banks will forbear and forbear until they see the value of the underlying asset, and then they might foreclose because then they can crystalize their losses,” Barkham said. “We think 2021 will be quite a strong year in economic growth … but … I think you will see more banks foreclosing,” especially on hotel and retail loans.
Although commercial estate as a whole has held up better than expected since the pandemic, the sector is becoming more distressed. The latest research from the Federal Reserve shows 1% of all commercial real estate loans were delinquent as of Sept. 30, up from 0.68% the end of 2019.
Bankers say they are closely monitoring their commercial loan portfolios. They’ve also had more latitude to offer deferral and forbearance programs under the Coronavirus Aid, Relief and Economic Security Act, and at the same time have built up massive reserves to cover losses.
According to Brian Foran, an analyst at Autonomous Research, the current circumstances make it nearly impossible for bankers to project how bad the portfolios might get. Due to the latest employment report, the decline in payroll and the delay in the coronavirus vaccine rollout, “There’s not a whole lot of clarity they’ll be able to give.”
Regarding the hotel and retail sector, PNC Financial Services Group Chairman and CEO William Demchak said they are “not getting better, they’re getting worse.” He also adds that “office space is going to struggle” depending on its location.
Jennifer Demba, an analyst at Truist Securities, said bank management teams are telling her they don’t expect to incur “any real” commercial real estate losses “until the middle of 2021.” But continued hiccups in the vaccine rollout will put further strain on commercial real estate loans, she said.
For now, banks are stuck in a credit “gray zone” of uncertainties, Foran said. Will people go back to the office or keep working at home? Will they want to return to in-store shopping? Will they go out to eat and stay in hotels and travel for business?
“Has the pandemic been a temporary pause or a permanent change?” Foran said. “Those are the known unknowns for banks. Ultimately we won’t know until we get through this.”