Unpacking the differences between multifamily and office CRE outlooks

Loans backing office and multifamily properties have caused angst among bank stockholders. For example, in January, New York Community Bancorp’s (NYSE:NYCB) stock slumped after it boosted its loan loss reserves to address weakness in the office sector and for potential repricing in its multifamily portfolio, among a number of other charges it took.

But the largest U.S. banks are well positioned to weather declining loan performance for office and multifamily (i.e., apartments) properties, Fitch Ratings said in a recent report.

Despite holding a majority of CRE loan balances, larger banks are more diversified and better positioned to withstand expected credit deterioration, particularly in office loan, Fitch’s Julie Solar and Brian Thies said in the report.

“Beginning in 2023 and continuing into this year, migration of non-owner occupied (nonOO) CRE into non-performing loans (NPLs) has accelerated and has since approached levels last seen at the peak of the global financial crisis,” they wrote.

And it’s unlikely that the industry has reached peak problem loan levels. During the global financial crisis, peak nonOO CRE losses didn’t occur until the migration to non-accrual status had slowed and reached a plateau.

NonOO CRE loan losses totaled almost $20B in cumulative net charge-offs from 2009 through 2011, or 3.5% of average loans. Bank losses during that period included $60.8B in construction, $10.1B in owner-occupied CRE, and $6.8B in multifamily for a total of $97B in CRE-related losses.

To date, Fitch said there have been $5.8B in nonOO CRE loan losses over the past three years. If performance deteriorates along the lines seen during the GFC, there would be an incremental $33B in nonOO CRE losses that the industry could face.

Multifamily and office sectors are on two very different paths, though. As a sector that’s traditionally stable over time, multifamily is expected to incur losses that are more geographically concentrated than the overall nonOO CRE sector. And eventually, the multifamily sector is expected to absorb the oversupply in those areas as favorable demographic trends support demand for additional housing.

The dynamics are not as favorable in the office sector, as a structural shift toward hybrid work models weakens demand. “Fitch expects recoveries on office loans will be lower than during the GFC given the structural changes to this sector,” Solar and Thies said.

The probability for loan delinquencies, at 23%, are highest for large office in high-telework markets, according to Federal Reserve estimates. By comparison, the probability for delinquency is 8.4% for large office loans in low-telework markets, 1.4% for small office loans, and 0.5% for non-office loans.

“Given the continued trend towards hybrid work and the resulting decline in demand for office space, it is uncertain that vacancies will recover in the near to medium term,” the report said.

The largest banks account for more than half of non-performing CRE loans at June 30, 2024, Fitch said, but bank with assets between $100B and $250B have a higher percentage of problem loans. Fitch attributes the weaker loan performance at larger banks to their exposure to investor-owned, central business district officer properties. Smaller banks, meanwhile, are likely to have office loans associated with suburban markets, which aren’t as affected by the shift to remote work, according to the Fed.

Of the 10 largest nonOO CRE lenders account for 22% of total loans balances at June 30, 2024, while the 10 largest multifamily lenders account for 38% of loan balances, Fitch said. Wells Fargo (NYSE:WFC) is the largest lender of nonOO CRE for all U.S. banks, representing 42% of equity capital, while JPMorgan Chase (NYSE:JPM) is the largest multifamily lender with loans representing 33% of equity capital at the end of Q2 2024.

Other relevant tickers: Vaneck Office and Commercial REIT ETF (DESK), Bank of America (BAC), U.S. Bancorp (USB), Truist Bank (TFC), PNC Financial (PNC), Citigroup (C), Capital One (COF), TD Bank (TD), Santander Bank (SAN), Valley National Bank (VLY), Webster Financial (WBS), Synovus Bank (SNV).