Commercial Real Estate Market Stress Poses a Challenge to Banks

July 06, 2023
By  Carl White

This post is part of a series titled “Supervising Our Nation’s Financial Institutions.”

A variety of factors—rising interest rates, persistent inflation, concerns about a potential recession and pandemic-related changes in where people work—have prompted concerns about the health of commercial real estate (CRE) properties and the bank loans that support them. Supervisors and economists at the Federal Reserve actively monitor CRE market conditions and the CRE loan portfolios of the banks it supervises.

Remote Work Shakes Up Office Sector

Thus far, most of the concern about commercial real estate is focused on the office sector, which accounts for about 15% of the $21 trillion CRE market. The national vacancy rate in the office sector was 17%, with rates around 20% in particularly hard-hit markets, such as San Francisco, Austin and Houston. While these cities are especially vulnerable because of their dependence on the softening tech sector, most of the country’s major office markets are affected, including Eighth Federal Reserve District cities such as Memphis, Tenn., and St. Louis. Further, actual office vacancy rates are likely higher as not all leased space is being occupied and space needs will likely decline when leases mature.

Much of the weakening in the office market can be attributed to an increase in remote work that began during the COVID-19 pandemic. The continuation of remote and hybrid work, even as the pandemic ebbs, has lowered the demand for office space, resulting in lower valuations, falling rents and rising vacancy rates. There’s also evidence that the problems in the office sector are spreading to nearby apartments and retail businesses that depend on office workers living and shopping near their workplaces.

Effect on Banks

Commercial real estate lending is a core activity at U.S. banks, and is especially important to community banks. Banks hold about 60% of loans associated with nonfarm, nonresidential properties, such as office buildings, hotels, retail stores and warehouses; two-thirds of those loans are held by community or regional banks. According to S&P Global, nine of the 17 banks that reported office loans on their books of at least $400 million pulled back on these loans in the fourth quarter of 2022, citing weakening demand and challenging economic conditions. For loans still on their books, a major concern is the ability of borrowers to refinance their loans at term end following substantial increases in interest rates over the past 18 months.

According to real estate data firm Trepp, $270 billion in bank-held commercial mortgages—of which about $80 billion is in office loans—will mature in 2023, a record. Many of the loans originated over the past few years have been interest only, which will magnify the cash flow issues of landlords when amortization begins.

Community Banks Have Greater Exposure to CRE Loans

For U.S. banks as a whole, CRE loans make up about a quarter of total loans outstanding. But for the universe of community banks—banks with assets of less than $10 billion—they account for nearly half of all loans. In the Eighth District, CRE loans make up just under half of all loans, regardless of bank size. (See the table below.)

Commercial Real Estate Exposure Indicators
U.S. Banks Eighth District Banks
2021:Q1 2022:Q1 2023:Q1 2021:Q1 2022:Q1 2023:Q1
CRE Loans as a Percentage of
Total Loans
All 23.0% 23.4% 23.8% 41.1% 43.3% 44.2%
<$10 Billion in Assets 42.3% 46.0% 46.4% 39.7% 43.6% 43.9%
CRE Loans as a Percentage of
Risk-Based Capital
All 122% 125% 131% 305% 303% 323%
<$10 Billion in Assets 342% 342% 357% 341% 358% 357%
Nonperforming CRE Loans as a
Percentage of CRE Loans
All 0.80% 0.56% 0.55% 0.55% 0.37% 0.34%
<$10 Billion in Assets 0.68% 0.44% 0.35% 0.64% 0.44% 0.37%
SOURCES: Reports of Condition and Income for Insured Commercial Banks (Call Reports) and author’s calculations.

Supervisors Monitor Concentration Risk in CRE Lending

Since 2006, banks have been subject to interagency guidance by the federal bank regulators on concentration risk in CRE lending (PDF). While there are no hard limits on CRE lending, supervisors may subject banks to extra scrutiny when total CRE loans exceed 300% of risk-based capital and the CRE portfolio has increased by 50% or more in the prior 36 months.There is a separate concentration marker for construction and land development loans of 100% of risk-based capital. Supervisors also carefully review the adequacy of banks’ risk management practices for CRE lending. For the industry overall, concentration ratios have risen about 15 percentage points for the U.S. and the District since the beginning of 2021 and are well over the 300% concentration benchmark, an indicator of the banking industry’s reliance on—and therefore the potential risk associated with—CRE lending. Roughly one-third of U.S. and District institutions have individual concentration ratios that exceed the 300% benchmark.

The proportion of CRE loans that are nonperforming—90 days or more past due or in nonaccrual status—remains low on an average basis and has continued to decline since 2020. At the end of the first quarter of 2023, just 0.35% of CRE loans were nonperforming at US. banks (0.37% at District banks). In the aftermath of the financial crisis, in contrast, nonperforming CRE loan ratios topped 5%. Federal banking supervisors continue to urge banks to work with creditworthy CRE loan borrowers who may be having financial difficulties. The most recent guidance to banks about prudent policies for CRE loan accommodations and workouts (PDF) was issued June 30.

What’s Ahead

Given the economic factors discussed earlier, it is likely that we’ll see continued stress in the commercial real estate market in the near term. While there are direct linkages to the commercial banking system—especially for community banks, many of whom have balance sheets with substantial CRE exposures—it is also important to note that the capital positions of most U.S. banks are much stronger than in past episodes where we’ve seen similar stresses. Bank supervisors will be particularly focused on CRE concentration risk, among other key risks, as we continue to see the impact of rising rates and a slowdown in domestic and global growth on our banking system.


  1. There is a separate concentration marker for construction and land development loans of 100% of risk-based capital.
About the Author
Carl White
Carl White

Carl White is senior vice president of the Supervision, Credit and Learning Division. View Carl’s bio.

Carl White
Carl White

Carl White is senior vice president of the Supervision, Credit and Learning Division. View Carl’s bio.

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This blog offers commentary, analysis and data from our economists and experts. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.

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