Unpacking the market's commercial real estate problem

If you're waiting for the commercial real estate apocalypse to hit, it might be a while — maybe forever.

Why it matters: Commercial real estate, particularly the office sector, is slumping — and the regional banks that lend to the space aren't looking so hot either — leading to concerns about a "doom loop."

• "There's definitely been an overreaction in the market about the relationship between banks and CRE [commercial real estate]," said Kevin Fagan, a senior director and head of CRE economic analysis at Moody’s Analytics.

Catch up fast: Market watchers were spooked by Federal Reserve data showing that the holders of commercial real estate loans are a highly concentrated group — with small and regional U.S. banks (those not in the top 25) collectively holding 67%.

Reality check: That eye-popping number turns out to be a bit misleading. Under the hood, the situation is more nuanced, as detailed in two reports from the Mortgage Bankers Association and Moody's Analytics.

• The 67% figure includes loans backed by traditional commercial real estate — apartment complexes, office buildings, retail space — but it also includes construction loans, loans backing farmland, or loans to owner-occupied properties like two-family houses.

State of play: The traditional commercial real estate lending market is incredibly diverse. That means borrowers should have options when it comes time to refinance.

• Banks — large and small — account for 39% of outstanding loans, per Moody's Analytics.
• Regional banks hold just 14% of outstanding loans.
• Fannie Mae and Freddie Mac also make a lot of these loans as do life insurance companies. (The chart above has the breakdown.)

Zoom out: Regardless of the lender mix, there’s sure to be pain in the commercial real estate market in the coming years — likely driven by growing distress in the office building segment.

• Office loans represent about 17% of outstanding commercial real estate debt, as calculated by the MBA.

• Rents aren't what they used to be, and building values are going to fall.
• With a glut of loans coming due soon, some will surely default. Morgan Stanley estimates that $1.5 trillion in commercial real estate debt is set to mature over the next two years.

But, but, but: "They're not systemic risks to the overall economy," says Fagan.

• For one thing, similar to what happened in the residential mortgage market, underwriting standards improved after the global financial crisis.
• Specifically, loan-to-value (LTV) ratios are much lower now, as the chart below shows. That means borrowers have more equity (and proportionally smaller loans) on their properties.
• That's going to help when it's time to refinance these loans. Borrowers may still have a shot at affording new loans, despite lower building values and higher interest rates.
• And when defaults do happen, lower LTVs should mean smaller losses for the lenders.