Commercial real estate is in trouble. A banking crisis will make it worse.

If there is anything commercial real estate owners don’t need right now, it’s a banking crisis.

Big owners of property around the country were already under pressure from the Federal Reserve’s aggressive campaign to raise interest rates, which raised borrowing costs and lowered building values. They also had lots of space still sitting empty in city centers as a result of more hybrid and remote work arrangements resulting from the pandemic.

Now they face the prospect that beleaguered banks, especially smaller ones, could get more aggressive with lending arrangements, giving landlords even less room to breathe as they try to refinance a mountain of loans coming due. This year, roughly $270 billion in commercial mortgages held by banks are set to expire, according to Trepp, and $1.4 trillion over the next five years.

“There were already liquidity issues. There were fewer deals getting done,” Xander Snyder, First American senior commercial real estate economist, told Yahoo Finance in an interview. “Access to capital was getting scarcer, and this banking crisis is almost certainly gonna compound that.”

Most of the banks that hold commercial real estate mortgages are small to mid-sized institutions that are experiencing the most pressure during the current crisis, which began this month with the high-profile failures of regional lenders Silicon Valley Bank and Signature Bank. The pressure on regional banks continued Friday, stoked by intensifying investor pressure on German lender Deutsche Bank as the cost to insure against default on its debt soared.

Smaller banks began ramping up their exposure to commercial real estate in the aftermath of the 2008 financial crisis, which was triggered by a housing bust, and stuck with it even after the pandemic emptied out many city-center properties and other forms of borrowing provided by commercial mortgage backed securities and life insurers dried up.

Signature was among the banks that made some of these bets, becoming an aggressive lender in New York City to office towers and multifamily properties. By the end of 2022 it had amassed nearly $36 billion in commercial real estate loans, half of which were to apartments. That portfolio comprised nearly one-third of its $110 billion in assets.

More than 80% of all commercial real estate loans are now held by banks with fewer than $250 billion in assets, according to a report by Goldman Sachs economists Manuel Abecasis and David Mericle. These loans now comprise the highest percentage of industry loan portfolios in 13 years, according to John Velis of BNY Mellon.

“There's a lot of commercial real estate that’s been financed over the last few years,” BlackRock Global Fixed Income CIO Rick Rieder told Yahoo Finance on Wednesday. "When you raise rates this quickly, the interest-sensitive parts of the economy, and particularly where there's financing or leverage attached to it, then that's where you create stress. That's not going away tomorrow." Commercial real estate, he added, doesn’t represent the same type of systematic risk to the economy as housing did during the 2008 financial crisis but there are “isolated pockets that can lead to contagion risk.”

Two early warnings of the danger that rising interest rates pose to commercial real estate came last month. Giant landlord Columbia Property Trust defaulted on $1.7 billion in floating-rate loans tied to seven buildings in New York, San Francisco, Boston and Jersey City, N.J. That followed a default by giant money manager Brookfield Asset Management on more than $750 million in debt backing two 52-story towers in Los Angeles.

Forced sales of more trophy buildings at large discounts are expected in the coming years as owners struggle to refinance at affordable rates. “Sellers will want the price that everyone was getting [back] in December 2021, and buyers are kind of even afraid to buy something right now cause they don't even know what the price of these buildings are,” Snyder said.

Banks were already squeezing terms on commercial real estate loans before this month’s chaos. According to the Federal Reserve’s latest senior loan officer opinion survey, nearly 60 percent of banks reported tighter lending standards in January for nonresidential and multifamily property loans.

“Bank lending standards had already tightened significantly over the last few quarters to levels previously unseen outside of recessions, presumably because many bank risk divisions shared the recession fears that have been widespread in financial markets,” according to a note last week from Goldman Sachs. More tightening of lending standards expected as a result of new bank stresses could slow economic growth this year, Goldman said.

Fed chair Jerome Powell agreed with that view at a Wednesday press conference following the announcement of another rate hike. He said he also anticipates a tightening of credit conditions as banks pull back, which will help cool the economy. “We’re thinking about that as effectively doing the same things that rate hikes do,” he said.

But he said regional banks with high amounts of commercial estate loans were not likely to become the next Silicon Valley Bank.

“We're well aware of the concentrations people have in commercial real estate,” he said. “I really don't think it's comparable to this. The banking system is strong. It is sound. It is resilient. It's well-capitalized.”

The larger commercial real estate world is still absorbing the shock of the Fed’s aggressive campaign, according to Marcus & Millichap CEO Hessam Nadji. The effects may not pose a systemic risk, he added, but they will add to the industry’s many challenges.

“Commercial real estate has been through a pandemic, very rapid recovery, then massive tightening of financial conditions unlike anything we’ve seen in modern history,” he told Yahoo Finance Thursday. “The last three years have moved the industry through a significant rollercoaster.”

Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv

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