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By Matt Tracy and Saeed Azhar
(Reuters) – Some of the biggest U.S. banks have singled out office-oriented commercial real estate as an area of growing concern as property values slump and tenant defaults rise amid rising interest rates in a slowing economy.
Faced with questions from analysts about their commercial real estate exposure (CRE) and the potential for losses, Wells Fargo (NYSE:), Citigroup (NYSE:) and JPMorganChase said on Friday that conditions were worsening in the industry.
“Weakness continues to develop in office real estate,” Wells Fargo Chief Executive Charlie Scharf told analysts. The bank earmarked an additional $643 million in the first quarter for credit losses, driven primarily by expectations of higher defaults on mortgage loans.
Stress in the commercial real estate sector could have broad implications for banks and the US economy, as defaults could restrict the availability of credit, exacerbating a recessionary scenario.
JPMorgan (NYSE:) Chief Executive Jamie Dimon said he expected tighter lending conditions, particularly around “certain areas of real estate”, and that this “increases the chances of a recession”.
Banks account for 54% of the overall $5.7 trillion commercial real estate lending (CRE) market, with smaller financial institutions holding 70% of these loans, according to Citigroup analysts. More than $1.4 trillion in US CRE financing matures through 2027 and about $270 billion this year, according to real estate data provider Trepp.
Loans secured by office-oriented real estate make up the bulk of the maturing debt load, followed by multi-family and retail real estate units. The question facing many borrowers today is whether they can refinance or restructure their loans to avoid default, banks and analysts say.
Older properties with high vacancies face the biggest refinancing challenge, experts say.
“Currently, corporate real estate faces the greatest refinancing risk” as companies reassess their needs, said John Guarnera, an analyst at RBC BlueBay Asset Management, amid massive layoffs across the country in recent months.
As the epicenter of the tech industry downturn, California’s CRE market has been hit hard. The cities of San Francisco and Los Angeles had an average office vacancy rate of 21.6% in the first quarter, according to data from Cushman & Wakefield.
Real estate loans involving offices in San Francisco now face the highest default risk of any US metro area, according to Trepp.
A subsidiary of asset manager Brookfield, for example, defaulted in February on $783 million owed on loans tied to two buildings in Los Angeles. Citigroup and Wells Fargo are among the venture’s initial backers.
Citigroup and Wells Fargo declined to comment and Brookfield did not respond to a request for comment.