The banking sector in the United States is already in turmoil, with several US regional banks collapsing. The next crisis may emerge in the US commercial property market. In an interview with the Financial Times, Berkshire Hathaway Inc.’s Charlie Munger said that banks are plagued with bad loans, indicating trouble coming in the US commercial property market.

The current banking crisis could be attributed to Fed’s aggressive strategy in dealing with rising inflation. However, banks may have to deal with another crisis on the horizon in addition to increasing interest rates – the cracks in the US commercial property market.

The Federal Reserve determined that commercial real estate prices have decreased, but values ​​have remained high in a report on the current assessment of the health of the US financial system that was published in May 2023.

The report noted that commercial real estate values ​​remain high, implying that property values ​​could experience a significant fall. According to the Fed, banks hold around 60% of commercial real estate loans, with two-thirds of those held by smaller lenders with less than $100 billion in assets.

Valuation pressures in the CRE sector have eased slightly since the November report but remained at high levels, the report stated. The aggregate CRE prices measured in inflation-adjusted terms have declined but these prices are based on repeat sales and may mask growing weaknesses, as more distressed properties are generally less likely to trade.

Capitalization rates at the time of property purchase, which measure the annual income of commercial properties relative to their prices, have turned up modestly from their historically low levels. While price declines were widespread across all property types, fundamentals in the office sector were particularly weak for offices in central business districts, with vacancy rates increasing further and rent growth declining since the November report.

In the January 2023 Senior Loan Officer Opinion Survey (SLOOS), banks reported weaker demand and tighter standards for all CRE loan categories over the fourth quarter of 2022.

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