Vacation pay

With the global commercial real estate sector continuing to struggle, the risk of contagion is rising, as is the prospect of bank failures, says Fitch Ratings.

In a new report, the rating agency said credit conditions for loans in the commercial real estate sector are expected to continue to deteriorate through 2025.

These negative trends will impact mortgage-backed securities, along with the banks, life insurers, asset managers and other financial market players with exposure to the sector.

“Losses should remain within ratings expectations for most issuers, given the wide dispersion of risks within the financial system,” Fitch said.

At the same time, it warned that a number of U.S. banks — particularly smaller banks that have larger exposures to the commercial real estate sector — could fail amid deteriorating credit trends.

“Weaker issuers with higher concentrations of riskier exposures could face downgrades. Lenders’ retreat from offices will exacerbate refinancing risk, adding to workout activity and credit losses,” it said.

The value of office real estate in particular has already dropped significantly, Fitch noted.

“This will continue as leases are marked to market and tenants trim their physical footprints in response to the post-pandemic secular shift in work patterns, and pivot towards well-located, highly amenitized and energy-efficient spaces,” it said.

In particular, older, lower-quality offices face the greatest risk of declining demand, Fitch noted, adding that they are likely to face “outsized property value declines, and even obsolescence.”

“This is already evident in some high-profile U.S. office markets and, increasingly, in gateway European cities with rising vacancies,” it said.

Against this backdrop, Fitch forecasts that the overall delinquency rate for U.S. commercial mortgage-backed securities (CMBS) to more than double to 4.9% in 2025, up from 2.3% this year.