Morgan Stanley Warns of Something ‘Worse Than Great Financial Crisis’ for Commercial Real Estate Market

A sign advertises commercial real estate for lease at a strip mall in Arlington, Va., on Feb. 15, 2022. (Saul Loeb/AFP via Getty Images)

Morgan Stanley analysts have issued a stark warning regarding the commercial real estate market in the wake of banking turmoil after the collapse of Silicon Valley Bank (SVB) and Signature Bank last month.

In a weekly Global Investment Committee note published on April 3, Lisa Shalett, chief investment officer for Morgan Stanley Wealth Management, noted that the commercial real estate sector faces a “huge hurdle” when it comes to refinancing, with commercial real estate prices potentially tumbling by as much as 4o percent from their peak.

Shalett pointed to multiple stock investors who have declared that the bear market is “over,” but noted that further turmoil in regional banking could tighten loan standards, which could in turn impact the real estate industry, an industry largely dependent on debt.

“Commercial real estate, already facing headwinds from a shift to hybrid/remote work, has to refinance more than half of its mortgage debt in the next two years,” Shalett wrote.

The chief investment officer noted that more than 50 percent of the $2.9 trillion in commercial mortgages will need to be renegotiated in the next 24 months when new lending rates are likely increased by 350–450 basis points.

According to data cited from Trepp by JPMorgan, nearly $450 billion in commercial real estate debt is due to mature in 2023, meaning a final repayment is due.

Office Vacancy Rates Soar

Shalett also noted commercial real estate has “primacy on the balance sheets of the regional banks,” which in the past cycle accounted for 70–80 percent of all new loan originations.

Commercial real estate prices have “already turned down and office vacancy rates have moved toward a 20-year high,” Shalett noted.

Morgan Stanley analysts forecast a peak-to-trough commercial real estate price decline of as much as 40 percent, according to Shalett, who added that that figure is “worse than in the great financial crisis” of 2008–09.

“Distress of this type has historically not only hurt the landlords and the bankers who lend to them but also the interconnected business communities, private capital funders, and owners of any underlying securitized debt,” Shalett continued. “The tech and consumer discretionary sectors will not be immune.”

Last month, Zillow chief economist Skylar Olsen warned that if the failure of SVB was indicative of a broader issue within the U.S. economy, such as a possible long-lasting recession, then unemployment rates could soar, income could decline, and the recent gains made through lower mortgage rates could effectively be wiped out, thus having serious impacts on the housing market.

Musk Weighs in on ‘Looming Issue’

Industrialist Elon Musk has also warned that the Federal Reserve raising interest rates could impact the commercial real estate industry and possibly set off an economic downturn, dubbing it “by far the most serious looming issue. Mortgages too.”

Musk’s comment came in response to a tweet on March 26 by “The Kobeissi Letter,” a weekly commentary on the global capital markets, which sent a tweet stating that more than $2.5 trillion in commercial real estate debt will mature over the next five years.

“This is by far more than any five-year period in history,” “The Kobeissi Letter” said, noting that rates have more than doubled and commercial real estate is only 60–70 percent occupied, which could trigger loan defaults.

“Refinancing these loans is going to be incredibly expensive and likely lead to the next major crisis. The worst part? Seventy percent of commercial real estate loans are owned by small banks. Rapidly rising rates are teaching everyone a valuable lesson,” it added.

The Federal Reserve raised interest rates by 25 points, increasing the benchmark federal funds rate to a range of 4.75–5.00 percent at the end of March and has not signaled a drop in rates anytime soon.

The latest warning from Morgan Stanley analysts comes after Bank of America warned late in March that the commercial real estate sector is likely to be the “next shoe to drop as lending standards for CRE loans to tighten further,” which could in turn impact regional banks that have high exposure to commercial real estate (CRE) loans.