The commercial real estate industry is in a downturn and could wind up dragging down the financial sector with it, according to a new report from Florida Atlantic University (FAU).
The root of the issue is the COVID-19 pandemic. Due to the transition to remote work, commercial real estate holdings are falling in value. Covid-spurred inflation, and the resulting higher interest rates, also adds stress to banks’ holdings.
FAU, accounting for data up to Q4 2023, previously reported in February 2024 on how commercial real estate could be an albatross for the country’s largest banks. With the first quarter of 2024 now behind us, FAU’s banking initiative has published new analysis from Dr. Rebel Cole, chaired professor of finance in FAU’s College of Business. This “screener” surveys the largest banks in the country and compares their total equity to their commercial real estate exposure.
Of the 157 banks surveyed in the screener, 67 of them have an exposure to commercial real estate more than 300% greater than their total equity. For context: the current industry average is for a bank to have commercial real estate exposure that’s 139% higher than their total equity. That average still underscores how much commercial real estate factors into financial institutions’ economy-bearing portfolios.
Dime Community Bank, based in New York state, has the highest total ratio of commercial real estate exposure to equity: $9.2 billion in exposure and $1.4 billion in equity, or a 653.7% difference.
According to Dr. Cole, the screened banks that are most vulnerable are Flagstar Bank (ranked 6) and Zions Bancorporation (ranked 22). Flagstar has only $9.3 billion in equity and $51 billion in commercial real estate exposure (a 553% difference). Zions has $26 billion in commercial real estate exposure and only $5.8 billion in total equity (a 439.7% difference).
“These are the two largest banks with excessive exposure to commercial real estate,” said Dr. Cole in a release. “Both rely heavily on uninsured deposits, which makes them vulnerable to a bank run similar to what forced regulators to close three large banks during spring 2023. Those bank closures have led to concerns about the stability of the U.S. banking system that persist to today.”
Cole notes that overexposure to commercial real estate is not confined to only the largest banks. Among banks of any size, 1,871 have total CRE exposures greater than 300%. Any ratio over 300% is considered excess exposure to CRE, according to the FDIC, which puts the bank at greater risk of failure.
“Three banks have failed in the past year and now we have several candidates where their exposure to commercial real estate is over 500%,” said Cole. “Should another bank fail, it’s likely that depositors will pull their money out of these highly exposed banks, which could lead to a banking panic similar to what we saw during spring 2023.”
The three closed banks Cole refers to are Heartland Tri-State Bank (closed July 2023), Citizens Bank (closed November 2023) and Republic First Bank (closed April 2024). While Republic’s assets were absorbed by the Fulton Bank (minimizing the damage of this closure), experts have said this failure means there is a very real possibility more could follow.
Proposals to alleviate this crisis have included repurposing commercial real estate buildings to restore their value. Boston, for instance, has begun a pilot program where developers receive tax incentives to remake empty commercial buildings into multi-unit residential buildings.
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For more information, view FAU’s full report here.
