Why Fitch Thinks The Coming Commercial Real Estate Crash Could Be Worse Than 2008

The storm clouds that have been gathering over America's commercial real estate market got a little darker, according to a recent analysis from Fitch Ratings. Fitch predicts the coming commercial real estate crash will wipe out more property value than the financial crisis of 2008. More ominously, Fitch believes any rebound from the commercial crash will be slower than the rebound from 2008, and the gains will be lower.

By any metric, America's commercial real estate market, specifically the office and retail sectors, is suffering. Commercial real estate vacancy rates in many of America's biggest cities are near 20%, a 40-year high. That's a problem for more reasons than the casual real estate observer might understand at first glance. First, there is no way any building with a 20% vacancy rate is generating profit — or even covering basic expenses like mortgage and insurance.

The larger issue is that any piece of commercial real estate's value is tied to how much money it's making. Commercial properties are not valued like homes, where factors like curb appeal and buyer's emotional attachment can prop up a home's value beyond what it would normally be worth. Commercial real estate valuation is a pretty cut-and-dried equation where prospective buyers use current rent rolls and revenue receipts as the primary metrics.

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That means a commercial office building — or an entire portfolio of commercial properties — with vacancy rates of 20% is depreciating every month. Fitch's analysis showed that office building values have already declined by 35% during the current investment cycle. That's a precipitous drop in value, but still less than the 47% that residential real estate experienced during the financial crisis.

However, Fitch doesn't see a commercial real estate bounceback like the one the residential market experienced after the 2008 crisis. Perhaps the main contributor to Fitch's bearish analysis is the post-pandemic reality that millions of American workers are not returning to their offices. A Goldman Sachs study conducted in late 2023 shows that 20% to 25% of American workers now work from home.  Office buildings can't recover and make money in this new environment.

The financial crash of 2008 was different because most of the distressed assets were single-family homes or condominiums, which are assets all Americans need to live a normal life. Despite the decline in values, it was only a matter of time before Americans got back on their feet and started buying houses again. Thanks to the Federal Reserve keeping interest rates so low, Americans bought homes in massive numbers after the crash.

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The COVID-19 pandemic permanently changed that math. Not only did it result in millions of Americans permanently shifting from working in the office to working at home, but post-COVID inflation forced the Federal Reserve to raise interest rates to put restraints on the economy. Those interest rate increases might have made sense at the time, but their kick-on effect for commercial office owners and lenders has been devastating.

Developers who took out short-term financing at low interest rates to gobble up as much commercial property as possible now find themselves unable to refinance their debt at the same rates. If they can refinance, they will pay roughly double the interest rates as before. When you've got dozens, hundreds or even thousands of assets in a portfolio and the interest rate doubles, your goose is cooked.

Add that to the fact that even if these semi-vacant office buildings find new tenants, the new tenants will be paying less per square foot than their predecessors, and it becomes easy to see why Fitch is forecasting a "protracted" rebound. That's a polite way of saying that commercial rents may never return to their prepandemic rates and even if they do, it will take a long time for that to happen.

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The rebound, if there is one, will probably not be strong enough to stave off a tidal wave of commercial debt that is set to mature in the next several years. By some estimates, nearly $3 trillion in commercial debt is set to mature by 2027, and almost $1 billion of that matures in 2024.

To sum it up, you have developers drowning in debt on rental assets they can't fill and mortgage lenders holding trillions of dollars in loans on toxic assets. When you look at the problem that way, it's easy to understand why everyone from Fitch analysts to the International Monetary Fund is sounding alarm bells about the possibility that the coming commercial real estate crash could be worse than 2008.

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