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Reading: CRE Prices Could Fall 40% This Year in an Adverse Fed Planning Scenario
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Private Banks Ranking > Blog > CRE Prices Could Fall 40% This Year in an Adverse Fed Planning Scenario

CRE Prices Could Fall 40% This Year in an Adverse Fed Planning Scenario

By 4 weeks ago
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After the Federal Reserve developed its 2023 stress test scenarios — the baseline and severely adverse sets of assumptions used in testing the resilience of large banks — Trepp projected potential commercial real estate property prices and portfolio losses under each.

This is scenario planning, so the most challenging assumptions aren’t a prediction of a likely outcome. But even the baseline wasn’t all that encouraging. Given the current economic climate, that shouldn’t be surprising.

Under the baseline scenario, the economy undergoes a slowdown and then a gradual recovery. Unemployment begins to increase, reaching 4.9% in the first half of 2024, and then recedes to 4.6% by 2026 Q1. CPI starts at 3.2% in the first quarter of this year (which already seems low), slowly declining until it reaches 2.2% at the beginning of 2026. The 10-year Treasury starts at 3.9% and finally lands at 3.2%; the 3-month peaks at 4.8% by the middle of this year and then declines. Real GDP growth is -0.5% now (measured numbers aren’t yet available), gets worse in the second quarter, then begins to improve, reaches 2.3% at the start of 2024, and by 2026 is down to 2.0%. That includes a moderate recession.

“Equity prices remain at their Q4 2022 level throughout the scenario,” Trepp writes. “Nominal house prices increase gradually by about 2% per year throughout the scenario, and commercial real estate prices increase by about 3% per year.”

In the severely adverse scenario, unemployment hits 5.6% by the end of Q1 2022 (which seems high, given numbers from January), quickly rises to 10% in the third quarter of 2024, and slows to 7.5% by Q1 of 2026. CPI is at 2.3% in 2023 Q1 (again, it seems low), drops to 1.3% at the end of this year, and by the beginning of 2026 is back to 1.6%. The 10-year Treasury starts at 1.1%, dips to 0.8% by midyear 2023, and in 2026 is up to 1.5%; the 3-month goes from 1.7% and by the third quarter of 2023 reaches 0.1%, where it stays. Real GDP growth closes 2023’s Q1 at -12.5% and then starts improving. By 2026, it’s up to positive 4.7%. In this scenario, there’s a severe global recession.

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“Asset prices drop sharply in the severely adverse scenario,” writes Trepp. “House prices and commercial real estate prices also experience large declines. In this scenario, CRE prices are projected to reach a level in the fourth quarter of 2023 that is nearly 40% below the level at the end of 2022.”

Trepp then examined 10,420 bank balance sheet loans ($89 billion outstanding value) and created a representative sample bank portfolio. “Term defaults present the main source of risk for the CRE market within this timeframe, but longer-term exposure to maturity defaults also presents a risk, especially within the severely adverse scenario, if prices stay depressed and interest rates stay high,” said the firm.

After the 13 quarters of the scenarios, overall, CRE values would fall by 0.7% under the baseline and 5.8% under the severely adverse. This varies by type. Lodging is hit hardest, losing 2.6% for baseline and 17.3% under severely adverse. Office, retail, and industrial all drop 0.5% in the first scenario and 5.1% in the second. Multifamily, though, has the smallest loss of 0.4% in baseline but is down 6.3% in severely adverse.

Under a second adverse scenario in which Trepp took a more conservative look at office and lodging, the overall portfolio drop is 6.7%. Lodging would actually do better then, at 16.5%, but office would be down 9.4%.

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TAGGED: Adverse, CRE, fall, Fed, Planning, Prices, Scenario, Year
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