Is the Commercial Real Estate Slowdown Here to Stay?

If you talk with commercial real estate bankers across the country, you can’t help but pick up on a subtle yet growing sense of unease. The retail space has struggled for some time thanks to the growth of e-commerce, but a similar trend has reared its head in upscale multifamily developments, where markets across the country seem to be taking a breather as well, according to bankers from Boston to Indiana to Oregon. All told, the year-over-year growth rate of commercial real estate loans has decelerated for five consecutive quarters, falling from 10.3 percent in the third quarter of 2016 down to 3.8 percent in the fourth quarter of last year.

Yet, there are also multiple positive trends exerting influence in the space. These include an increase in government-backed development initiatives, a continued building out of urban centers and optimism that a lower corporate tax rate will spur business investment and fuel the ongoing economic expansion for a few more years before the cycle inevitably turns down.

“There really isn’t anything outwardly negative that we know of at the moment,” says Jane Adler, vice president of commercial real estate banking at Brookline Bank, a $6.7 billion asset bank based in Brookline, Massachusetts, a suburb of Boston. “But those of us who have been around for one, two, three or even four cycles know that now is the time to keep your eye out for things that could intervene and change the trajectory of the economy.”

Bankers in the middle of the country are similarly cognizant of what, from all accounts, appears to be a well-seasoned cycle. “We’re seeing fewer new projects being announced,” says Kevin O’Driscoll, executive vice president of commercial real estate at Old National Bank, a $15.1 billion asset bank based in Evansville, Indiana. “The inflection point seems to have come in the third quarter of last year. We had a lot of closings pushed from late 2016 into early 2017. It was really busy. But as last year progressed, the number of new projects being announced slowed down.”

The same feeling is evident beneath the surface in the Northwest. “We are certainly closer to the end [of the cycle] than the beginning,” says Clint Stein, chief operating officer at Columbia Banking System, an $11.8 billion asset bank based in Tacoma, Washington. “After all, this has been one of the longest economic recoveries in history. To use a sports analogy, right now feels like the seventh-inning stretch. There still is more game to be played, but in general, the amount of financing opportunities is less than a few years ago.”

The still-nascent slowdown is not uniform across all types of commercial real estate. While luxury multifamily development down in Florida and elsewhere seems to have reached a saturation point, other sub-sectors are picking up the slack. “We are seeing a tremendous amount of activity in assisted living development and self-storage in our markets,” says Chuck Cross, executive vice president of commercial banking for Seacoast Bank, a $5.8 billion asset bank based in Stuart, Florida. “And though the number of retirees as a percentage of the whole is not projected to change, the overall population numbers will. [So we will] need to build more retirement facilities to meet the demand.”

In the Northwest, “hotel financing has been particularly robust in the last few years [and] industrial warehouse financing requests have been increasing as well,” says Stein. On the other hand, some parts of the brick-and-mortar retail sector continue to suffer from the growth of e-commerce. “The ‘Amazon Effect’ is very real and is greatly impacting the retail space,” says Stein.

One of the more interesting trends that banks across the country have observed of late is the growth of credit unions in the commercial real estate space. “Around the Boston area, we are seeing credit unions doing larger transactions than they have in the past,” says Adler. “And smaller banks seem to be following their lead, doing bigger deals.”

Stein is seeing the same thing throughout Columbia Bank’s footprint in Washington, Oregon and Idaho. “Most banks in our market are spending considerable time trying to figure out how to compete with the newer disruption of credit unions entering the space. Some of the larger credit unions are originating eight-figure CRE loans, which is substantially upmarket from where we have traditionally seen them.”

And O’Driscoll has observed this throughout Old National Bank’s operations in Indiana, Kentucky, Michigan and Wisconsin. “We’ve seen more small lenders, whether that’s credit unions or banks below $1 billion in assets, stretching to do $20 million deals.“

Another trend taking hold is an increase in government support of urban and affordable housing development projects. The Governor of Massachusetts recently rolled out the Housing Choice Initiative. “It provides benefits to towns based on housing production,” says Adler. “It’s not fully detailed yet, but conceptually it’s out there and it’s structured as a carrot instead of a stick, which I like.”

“Right now, we’re seeing that small communities are being smart about development and willing to provide economic incentives to increase their tax base,” says O’Driscoll. “We’re seeing the downtown living trend that started in the largest cities, 10 million-plus population centers, trickle down to the second, third and even fourth-tier population centers, like Fort Wayne, Indiana, and Lexington, Kentucky.”

One city where the urban revitalization trend has matured is Los Angeles, California, notes Doug Bowers, the recently appointed CEO of Banc of California, a $10.3 billion asset bank based in Santa Ana, California. “Downtown L.A. is a very different place today than it was three years ago. It’s become a haven for young apartment dwellers taking advantage of new apartments being built. You can finally now both work and live there. It wasn’t until 2010, in fact, that the greater downtown area had a grocery store,” says Bowers.

The final common trend that commercial lenders across the country have uniformly observed is an increase in the size of the average project. “Many regional community banks have significantly grown in size since the great recession and, as a result, have received larger loan requests,” notes Stein. “This coincides with a trend where different banks come together and partner on a particular project as opposed to going it alone. This approach allows some banks to stay active in this space while managing any CRE concentration limits they might have.”

Ultimately, however, whether the incipient pull back in commercial real estate development gathers steam or not, there is universal agreement that the long-term trend in demand is positive. “One thing that gets missed in the real estate sector and the general news is the fact that the U.S. population is growing,” says O’Driscoll. “We’re at about 324 million people right now in the U.S. and we’re projected to grow to 400 million by 2050. That’s a lot of new household formations.”