Economists doubt that a 'doom loop' will hit office real estate

By Greg Robb

Many factors argue against a systemic crisis, NABE panel says

A panel of experts on Thursday said that it was an overstatement to say that the office segment of the commercial real-estate market was in "a doom loop."

Downtown office buildings in many cities have dropped in value with shifts in work behavior. Values of office buildings already have fallen an estimated 35% since peak pandemic levels. Fears of rising defaults on loans tied to the properties are also rising, causing stress on banks.

But experts on a panel at the National Association for Business Economics conference in Washington, D.C., stopped short of saying this would result in a systemic financial crisis, or even a "doom loop" that makes it difficult for neighborhoods to overcome.

"Intellectually, based on the data, we've concluded no doom loop fears here - the industry can make its way through," said Cristian deRitis, deputy chief economist at Moody's Analytics.

"There is quite a bit of capital in the system. The distribution of CRE loans is not just concentrated in banks," he said.

Several other mitigating factors also appear to be overlooked by doomsayers.

Aaron Klein, a senior fellow in economic studies at the Brookings Institution, said that a combination of too much leverage and a fundamental mispricing of assets is needed to cause a financial crisis. He noted that commercial real estate doesn't meet the criteria because it isn't clear that assets are very mispriced.

Office use is also now growing, as the pandemic-era move toward working from home is reversing, he added.

"It seems as if things are flipping back after COVID," Klein said, noting how the economists were gathering in person for a convention in Washington. Life is returning to pre-COVID norms and "people are returning to work, generally," he said.

And even though many people are now only working in the office three days a week or less, that won't necessarily cause a disaster. "Commercial real estate doesn't care how often you're there - as long as you sign the lease," Klein added.

Additionally, real-estate firms are exploring other uses for distressed buildings.

Erin Patterson, global co-head of research and strategy for real estate at Manulife Investment Management, said there has been an increase in high-yield credit funds supplanting some of the financing needs in commercial real estate.

"That's an escape hatch from this doom loop," she said.

In addition, banks "don't want the keys back" to problem buildings, she added, and are working on ways to create value so that office real estate can remain on the books.

DeRitas said he was worried about the "fear factor," a change in psychology about the sector that could trigger more bank runs.

But Klein said the real-estate sector is benefiting from "massive regulatory forbearance." There has been only a few bank failures since the March 2023 crisis that saw the collapse of Silicon Valley Bank and other institutions, and regulators want to give banks more time because they don't want to bail out uninsured depositors, he noted.

DeRitis said that office real estate's current problems are just an exaggerated crisis, one similar to what the sector has seen before.

"CRE investors have been through multiple cycles - they are a very creative bunch," deRitis said. Buildings will be repurposed and cities will reinvent themselves, he added.

-Greg Robb

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02-15-24 1610ET

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