INSIGHTi
Commercial Real Estate Markets and Potential
Macroeconomic Stress
December 6, 2023
The commercial real estate (CRE) industry comprises different real estate sectors, including office,
industrial, and retail space, as well as multifamily housing (e.g., apartments). Recent economic trends
have some economists concerned about conditions in CRE markets, although economic conditions affect
each of these segments differently. This Insight discusses the impact of changes in inflation and interest
rates as well as post-pandemic work patterns on CRE.
CRE and the Economy
The CRE industry relies heavily upon borrowing, so tightening credit conditions or the devaluing of
commercial property used as collateral can affect the ability of builders to obtain financing for new
construction. Higher borrowing costs can reduce CRE growth or increase rents for CRE occupants. In
turn, losses in CRE can affect those individuals and institutions that finance CRE, potentially causing
further ripple effects on the economy.
Conditions in certain CRE markets have some concerned about this sector. In the lead-up to and during
the COVID-19 pandemic, interest rates throughout the economy were low, allowing for relatively
inexpensive borrowing. As the pandemic and recovery progressed, supply chain constraints and other
complications led to rapid inflation, ultimately leading the Federal Reserve to raise interest rates, thereby
raising borrowing costs and tightening credit conditions.
The office sector in particular is now showing signs of stress. The pandemic resulted in a structural shift
away from in-office work, resulting in high vacancy rates for this segment of CRE that persist today. Due
to the convergence of work-from-home policies and other economic pressures, many companies that
would typically rent space from the office subsector of CRE owners are not renewing their leases. This is
evidenced by higher office vacancy rates, which hit all-time highs earlier this year. Consequently, office
property leases have fallen, generating lower revenues from rent, potentially imperiling the ability of the
property owners to pay back financing costs. To minimize losses, some CRE owners have been willing to
break leases and renegotiate terms with tenants.
However, not all CRE segments are performing similarly. According to a recent October 2023 analysis
from the National Association of Realtors, multifamily and retail properties are performing better than
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they were pre-pandemic, and industrial properties are back to pre-pandemic standards. Evidence cited
includes:
• a 33% increase in net absorption and a 17% increase in unit deliveries compared to the
previous year for multifamily properties,
• a decade-low vacancy rate for retail properties, and
• similar vacancy rates and net absorption to pre-pandemic levels for industrial properties.
Whether some or all of these subsectors will remain resilient is yet to be seen.
Macroeconomic Implications
CRE activity is a significant contributor to overall economic activity. Therefore, a downturn in CRE
markets could lead to general macroeconomic stress. As illustrated in Figure 1 below, investment in CRE
comprised nearly 3% of total economic activity in 2022, although this percentage has been falling in
recent years.
Figure 1. Private Fixed Investment in CRE as a Percentage of GDP
2007-2022
Source: Bureau of Economic Analysis, National Income and Product Accounts, Table 1.1.6 and 5.4.6.
Notes: Owing to data constraints, investment in multifamily structures does not include brokers’ commissions and other
ownership transfers or net purchases of used structures and is therefore likely an underestimate.
CRE also likely plays a significant role in local economies. The availability and cost of CRE space can
affect both local residential and business markets, and taxes from the properties themselves and the
residents and businesses that occupy them can contribute revenue to local governments. Given the stress
in office space specifically, it is possible that certain local economies may be disproportionately affected
compared to the national economy. For example, some observers are concerned about a so-called urban
doom loop, in which stress in office real estate leads to economic declines in downtown centers.
At a regional or even national scale, one particular policy concern is how stress in the office subsector
might stress banks, which hold a significant amount of CRE debt on their books. According to the latest
Federal Reserve data, banks hold around $3 trillion in CRE debt. CRE mortgages are financed on shorter
terms than are residential mortgages, often with balloon payments due at maturity. Trepp, an industry
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analysis firm, estimates that $448 billion in CRE loans are maturing in 2023, with about $270 billion of
that coming from bank loans. Further, regarding the retail subsector, many tenants are considering
whether or not to renew their leases. A loss of rental income would lead to higher default rates among
CRE owners. This is compounded by the coinciding maturities of many CRE mortgages, which will
accelerate defaults if rental income cannot sufficiently offset the balloon payment obligations or if
alternative financing cannot be procured. (For more on bank exposures to CRE, see CRS Insight
IN12278, Bank Exposure to Commercial Real Estate, by Andrew P. Scott.)
Certain economic trends may bolster the CRE market in the near term. Economic growth has
outperformed expectations, inflation has receded notably, and many other economic indicators are
generally stable. However, high interest rates, supply chain constraints, and recent stress in the banking
system could contribute to slower growth or stress in certain sectors, including CRE. Whether stress in
CRE and banks would lead to economic or financial turmoil is highly debated. Even if the impact on the
banking system is mild, CRE market stress, among other conditions, may lead to a further contraction in
credit conditions.
Author Information
Lida R. Weinstock
Andrew P. Scott
Analyst in Macroeconomic Policy
Analyst in Financial Economics
Disclaimer
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