The Federal Reserve is closely monitoring commercial real estate borrowing as a potential risk to financial stability, according to a new report from the nation’s central bank. Factors such as “dramatically reduced” demand for office space could lead to corrections in the values of office buildings and downtown retail properties.
Moreover, the rise in interest rates over the past year increases risks that CRE mortgage borrowers will not be able to refinance their loans when they reach maturity. With elevated valuations, any correction in property values could result in significant credit losses by holders of CRE debt.
Losses on CRE loans depend on leverage because owners with substantial equity cushions are less likely to default; additionally, those with high loan-to-value ratios are typically harder to refinance or modify.
