Rising interest rates, inflation and the pandemic’s impact on office occupancy rates have created a challenging environment for the commercial real estate market, as well as lenders with significant exposure to the space.

Amid pressure to reduce their exposure to commercial-property, some large banks are looking to offload their troubled commercial real estate loans, but with little success, according to Bloomberg.

Firms like Goldman Sachs and JPMorgan Chase, as well as Capital One and M&T Bank have struggled to sell debt backed by offices, hotels and apartments in recent months, the wire service reported last week.

The challenges associated with the troubled CRE market are especially acute for regional lenders, which account for 68% of all commercial real estate loans, according to a Bank of America research note.

“Commercial real estate [is] widely seen as the next shoe to drop," Bank of America's Michael Hartnett told Business Insider in March, shortly after the collapse of several regional banks sparked concerns that banks would begin to tighten lending standards.

While it’s not clear if or when the commercial real estate market will rebound to pre-pandemic levels, experts say there are steps that banks with significant exposure to the space can take to help mitigate the risk of significant losses.

1. Address vacancy concerns

When the issue is related to vacancy, banks should evaluate the situation surrounding key tenants, said Ken Bauer, chief lending officer at Phoenix, Arizona-based OneAZ Credit Union.

Banks need to determine whether tenants are likely to renew their leases and should consider factors like remote work and the tenant's intentions regarding office space usage, he said.

“Does the tenant plan to return employees to the office, reduce square footage or potentially vacate the premises entirely? Given the prevailing market conditions with escalating vacancy rates, how does the building owner intend to position the property and attract new tenants?” he said. “The financial institution must also assess whether they’re willing to accept the less-than-ideal cash flow to sustain the loan and prevent default.”

While the adoption of remote work has had a dramatic and potentially permanent impact on office space, there is an opportunity for borrowers to repurpose those spaces, according to David Schiff, head of retail and consumer banking at consulting firm West Monroe.

“Shifts in the nature of in-person work will undoubtedly impact office space over the next few years, particularly in high-growth markets, but the nature of those markets also makes it easier for landlords to repurpose the space into residential apartments, hotels, mixed use and shared working spaces that remain in high-demand,” he said.

2. Communicate early and often

Bauer said the key practices to avoiding default or foreclosure are to communicate early and often, and implement proactive management steps to stay ahead of potential issues before they escalate into serious problems. 

“Lenders are keen to avoid scenarios involving default or foreclosure, as these situations are detrimental for all parties involved,” Bauer said. “By engaging in open communication and pre-emptive actions, financial institutions can better navigate challenges and mitigate the risk of significant losses.”

While many firms are taking a broad-brush approach to accruing for potential losses related to CRE based on market and sector, Schiff said bank managers also need to take a relationship-based approach to get a deeper understanding of individual clients’ unique positions and plans.

“Banks who take a true relational approach to partnering with clients will experience substantially lower losses than those whose relationships are really just transactional,” he said. 

3. Consider concessions

Banks should also consider whether there are short-term concessions that they can provide to assist a CRE borrower, Bauer said. 

“Additionally, assess whether the borrower has access to liquidity to make loan payments promptly, thereby minimizing the impact of higher interest rates on the repayment structure,” he said.

But Schiff warned that concessions should only be on the table for the right client in the right situation.

“Banks who have a true understanding of their clients’ near-term needs and long-term profit potential holistically will be able to make more nuanced decisions than those who take a deal-by-deal view,” he said.