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Monday, May 20, 2024

Why Financial Institutions Need to Take Proactive Measures for their CRE Holdings

As analysts closely monitor global events and their impact on financial markets, the financial state of commercial real estate continues to be a primary focus for many. Banks and lending institutions around the U.S. have not forgotten the Great Recession of 2008 and how commercial real estate portfolios impacted balance sheets and profitability. While the Great Recession’s impact to residential real estate markets outpaced commercial real estate defaults, the potential for a moderate recession or cycle correction in 2023 will look much different than any others in recent history.

The current state of commercial real estate varies greatly by asset class, and these classes may currently benefit, or suffer, from various dynamics specific to their industry position. Banks holding debt on investment multifamily or operating assets (industrial or other logistics) will see different, more subdued market correction components than those holding office buildings or retail which stand to face greater headwinds over the next few years.

According to the Mortgage Brokers Association, office properties posted a 54% YoY decrease in lending for Q4-2022. And, according to Bloomberg, the $175 billion of global real estate credit already in distress will continue to grow. This is largely due to protracted decisions made by companies as to how to right-size their portfolios when considering a recession, raising interest rates, declining office tenancy, and shifts to hybrid/remote work amenities. This is leading banks to boost reserves for potential losses attributed to commercial real estate loan defaults.

Banks and other lending institutions may continue to track borrower performance and real estate asset values, two of several tools utilized by such entities, in assessing risk within their portfolios during a correction environment. DEODATE’s approach with bank and lending clients facing imminent correction in their respective portfolios is to do so strategically, proactively, and with initiatives unique to respective asset classes. Lending institutions are encouraged to assess multiple factors in their goal to limit portfolio risk exposure.


• Conduct market analysis and disposition strategy on current or potential borrower special/distressed/toxic real estate assets
• Proactive analysis of borrower (relationship) lease options coming up, notably in manufacturing or operating facilities, to understand how fixed escalations (3-5% of current base rate) or FMV (potential 25%-250% of current base rate) will impact DSCR and global cash flows
• Analysis and downside protection/risk analysis of office portfolios specific to market and vacancy factors
• Proactive analysis of borrower refinances to see how updated debt environments will impact DSCR
• Create and deliver information collateral/ training to the borrower base on how to best position and negotiate operating assets over the next year
• Analysis of potential cash infusion necessary for property portfolios based on the trajec- tory of the market over a 1-3+ year period
• Data gathering and issuance to the borrower to assist in lease/acquisition negotiation such as retail gap, competitive reports, etc.
• Analysis of necessary reserves based on asset risk and potential valuation

Any bank or financial institution with a sizable portion of their business being dependent on returns from commercial real estate should be prepared for the potential of increased disruption to this industry. Many analysts, including our own, predict that we’ll see continued uncertainty, so it’s important for banks to be able to forecast the future standing of their loans as accurately as possible and to have sound downside protection strategies in place to mitigate risk and limit financial losses.

Successful mitigation of risk/losses by banks over the next 6-8 quarters will be determined by the proactive nature of their strategy and implementation. The best time for banks and lenders to make a strategic assessment of their commercial real estate portfolios is long before a correction occurs.

Rodrigo Gonzalez is CEO & managing partner at DEODATE. For the last 17 years (10 with DEODATE) his teams have advised on hundreds of engagements for over $4 billion of commercial real estate and public infrastructure projects, exclusively in real estate strategy.

Learn more at deodatecorp.com.

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