Rising commercial real estate prices in the U.S. could intensify problems in an economic downturn further down the road, the president of the Boston Fed said this week before a banking supervision conference.
“In the United States the two most significant recent periods of financial instability were accompanied by declines in real estate values that impacted financial institutions and intensified the business cycle,” Eric Rosengren said at the Asia-Pacific High Level Meeting on Banking Supervision in Indonesia on Wednesday.
Rosengren pointed to both the recession following the 2008 financial crisis and the recession of the early 1990s to illustrate a familiar theme: In the ultra-prolonged, ultra-low interest rate environment, many banks increased commercial lending in an effort to “reach for yield,” causing regulators to worry. And while the commercial real estate sector has been trending up for some time, Rosengren said that holdings of commercial mortgages in the banking sector increased 8.9 percent and holdings of multifamily mortgages increased 12 percent over the past year alone.
“This growth has occurred while bank supervisors have been cautioning about the potential risks emanating from the high valuations in some sectors of the real estate market,” he said.
Nodding to Boston, Rosengren expressed concern about apartment building prices, especially as capitalization rates have remained low and price increases have outpaced growth in net operating income.
“As the economy improves, higher market interest rates would normally slow new construction as well as valuations in interest-sensitive sectors,” he said. “However, the slow recovery and the possibility that equilibrium interest rates may remain relatively low, reflecting demographic and productivity trends, may make it more difficult to slow down the real estate sector with higher interest rates.”
Rosengren cautioned that he wasn’t forecasting trouble, though this is not the first time he’s raised the issue of risk in the commercial real estate sector. But because real estate holdings are widespread and the tools for handling valuation concerns are somewhat limited, he said, “… we must acknowledge that the commercial real estate sector has the potential to amplify whatever problems may emerge when we at some point face an economic downturn.”
“I am not expecting such problems in the near term, but would say that awareness, informed by data and analysis, is a first important step to continued actions that can head off unwelcome problems in the future,” he said.
