Commercial real estate on shaky ground as industry enters a cyclical bear market

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Vacancy rates are rising and will continue to rise as the economy weakens, putting downward pressure on rents and top-line revenue

interest ratesLenders such as banks and pension funds will see their collateral values decline as the value of buildings plummet. Loan-to-value ratios will drop, making lenders unwilling or even unable to refinance borrowers. This will put further pressure on the financial system.Between the fourth quarter of 2009 and the last quarter of 2022, the Fed’s commercial real estate index, which reflects the value of buildings, rose by 128 per cent, or about 6.5 per cent annually.

But now, the adoption of remote working will make for a particularly challenging period ahead. The days where anyone with enough capital could thrive in commercial real estate are over. Investors would be wise to underweight commercial real estate investment trusts in their portfolios, or at least be conscious of debt levels and leases coming due relative to loan maturities in the near future. Office REITs are trading at an almost 40-per-cent discount to net asset value, so the market is already signalling problems ahead. Those looking for buying opportunities should seek out names with low levels of leverage.We are in for a bumpy ride.

Tom Czitron is a former portfolio manager with more than four decades of investment experience, particularly in fixed-income and asset-mix strategy. He is a former lead manager of Royal Bank’s main bond fund.

 

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