Garnet Capital Advisors Blog

Excerpt: The commercial real estate loan market is in a state of instability. Though prices climbed steadily after the Great Recession, there are signs that the sector has reached a period of 'cool down'. 

Commercial real estate prices have appeared to reach their cap as the overall sector is experiencing a cool down.

The commercial real estate sector is in the midst of a cooling-off period, as prices have appeared to taper off after a steady climb since the aftermath of the Great Recession.

Prices have managed to remain rather buoyant, however, largely as a result of the decrease in interest rates in 2017 and an increase in various investment funds. In fact, it's the extended low-interest rate environment that we've been immersed in over the past decade that has helped drive commercial real estate investments.

Yet cap rates have been dropping over the recent past, reflecting the expected annual ROI. Such a decline in cap rates is shrinking investor and landlord profits, raising valid concerns that this particular sector could be in a risky position should the stock market or economy take a hit.

Commercial real estate purchases declined 10 percent in 2016 from 2015, and it seems as though the trend is continuing into 2017. In the first two months of this year, domestic investors bought $50.3 billion worth of commercial real estate, a far cry from $80.1 billion over the same time period last year.

Lending Slows in the Commercial Real Estate Market Realm as the Bull Run Loses Steam

As the sale of commercial properties begins to slow and lenders continue to scale back on CRE lending, prices could continue on a downtrend.

Big banks that have long been active in the CRE lending realm have been showing signs of slowing down, causing a ripple effect that is being felt in smaller community banks.

CRE lending has slowed and investors are selling off commercial property assets as the bull run in this sector appears to have reached its peak.

It's expected that overall loan volumes will plummet three percent this year from the 2016 level down to $478 billion. With a slowdown in the demand for commercial real estate comes a subsequent decline in the need for loans within this realm.

As the value of commercial real estate steadily increased for almost a decade to reach their peak, many anticipate that the sector will start to deflate very soon.

Concern Looms Over Lenders' Vulnerability to Risk

In addition to the slowdown in prices and loan demand in the world of commercial real estate, there is also the concern over the vulnerability of banks and lenders that practice less-than-prudent CRE lending. Over 500 financial institutions with high-risk asset concentrations on the books were insured by the FDIC by the end of 2016, a slight increase from the 474 institutions in the third quarter of 2015.

Many financial institutions continue to remain overly exposed to risky asset levels by maintaining the notion that the commercial real estate market is a vigorous one.

But banks with higher concentrations of CRE assets could be at risk if the asset quality performance of this particular sector gets significantly worse as interest rates begin to rise or economic conditions deteriorate at some point.

Optimizing Loan Portfolios as the CRE Lending Sector Slows Down

As the commercial real estate sector continues to show signs of a plateau and lending for such property types falls in demand, financial institutions of all sorts need to reexamine their loan portfolios. In short, banks need to keep a close eye on their loan portfolios, adding good loans and selling those that are exhibiting stress.

At Garnet Capital, our team has a comprehensive understanding of the loan sale and acquisition process, allowing us to provide expert assistance to financial institutions with the asset acquisition and selling process. By pairing banks with the right partner, we can assure banks an optimal transaction to ensure full regulatory compliance and minimal risk when enhancing loan portfolios.

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