US Commercial Real Estate could lose 40% of its value

According to the Chief Investment Officer at Morgan Stanley Wealth Management, CRE prices in the US could fall by 40% from their peak.

Morgan Stanley Wealth Management recently released some concerning information for the commercial real estate (CRE) industry in the United States. According to Lisa Shalett, the Chief Investment Officer at Morgan Stanley Wealth Management, CRE prices in the US could fall by 40% from their peak, which is even worse than what happened during the global financial crisis in 2008. This is a result of several headwinds that have hit the industry, including rising office vacancy rates due to the trend of working from home and higher interest rates that make it challenging for investors to refinance a lot of debt.

According to Shalett's weekly report in the Global Investment Commission (GIC), more than 50% of the $2.9 trillion in commercial mortgages will need to be renegotiated in the next 24 months -- this is when lending rates could rise between 350 and 450 basis points. Regional banks are at high risk, as they hold about 70% to 80% of commercial real estate debt.

Part of the problem is that high borrowing costs and tightening financial conditions pose obstacles for major real estate investors who are seeking to refinance a series of loans. Nearly $450 billion in commercial real estate debt will come due in 2023, according to data cited by JPMorgan from Trepp.

The Federal Reserve raised interest rates to 4.75% from near-zero 12 months ago in an attempt to cool inflation, and this has had a tremendous impact on commercial real estate valuations. With the trend of remote work since the Covid-19 pandemic began, there has been a reduction in consumer demand for office space, causing the US office vacancy rate to rise to 17% at the start of this year from around 12% at the beginning of 2022.

Experts, including Mike Matousek, the head of trading at US Global Investors, and CEO Scott Rechler of RXR Realty, see more risks on the horizon for the industry. Some of the concerns are that there is $1.5 trillion in commercial real estate debt maturing over the next three years, much of which was borrowed when the prime rate was at or near zero. This debt needs to be refinanced in an environment where interest rates are higher, which could result in lower values, especially in a market with less liquidity.

Moreover, Shalett warned that the current challenging situation could hurt many building owners and lenders, not to mention impact the business community, investors, and securities holders. She further warned that sectors such as technology and non-essential consumption will not be "immune" to this wave of risks. Even Tesla CEO Elon Musk updated on Twitter that commercial real estate debt is a serious issue facing the US economy.

Overall, the CRE industry in the US is facing multiple headwinds and risks that could have a significant impact on the industry and the broader economy. It remains to be seen how deep the crisis will be and for how long, but it is clear that major players in the industry need to be vigilant and prepared for potential downturns.