OCC Underscores Multifamily as a Risk to the Banking System

The semiannual risk perspective from the Office of the Comptroller of the Currency (OCC), one of the primary national banking regulators, says that banks are facing more credit risk from commercial real estate.

It pays heed to office, the asset class that most worries regulators eyeing banks that may be over extended in this category, But this year’s report also spent a good deal of ink focusing on multifamily as well.

Multifamily has seen “deteriorating fundamentals” last year, according to the OCC. National vacancy rates increased from 6.5% in the last quarter of 2022 to 7.6% in 2023 Q4. The reason was, as GlobeSt.com has reported, a rapid increase in unit deliveries in the south, southeast, and mountain regions. There were other headwinds, like higher interest rates and operating expenses. That was particularly the case in markets like New York City with rent control regulations that prohibited owners from more rapidly raising rents. “Multifamily fundamentals are forecast to improve in late 2024 as population growth and fewer construction starts will help bring demand and supply into better balance,” they wrote. But projections for vacancies in 2026 at 8% are higher than today.

Perhaps more worrisome the OCC appeared to lump multifamily with office as it discussed the stress the two asset classes are experiencing.

“Office and multifamily loans, particularly those with interest-only terms, set to refinance over the next three years pose additional risk. Sticky inflation and elevated interest rates may increase financial stress in some households and weigh on overall consumption growth.”

That said, its main focus was on the risks posed by office.

The analysis looked at multiple factors, including current and projected CRE vacancy rates stretching out to 2026. Office “incurred seven consecutive quarters of negative net absorption, pushing the vacancy rate to a new high of 13.5 percent” in 2023 with hybrid and remote work showing “little change,” which continued to “weigh on office occupancies.” The expected 2026 vacancy was nearly 17%.

The imbalance between supply and demand has also affected potential rent and net operating income. As a result, they argued, investors have been pulling back from the office sector, “causing the national average office property price to drop by about 13 percent from its late 2021 peak, with an additional 15 percent decline expected by year-end 2025.” Central business district office properties have faced “the most deterioration in fundamentals.” Stress factors have also expanded to suburbs since last year. “The deterioration in economic indicators has also affected property values in certain markets.”

Banks have raised lending standards and seen weaker CRE loan demand, which may well be a result of the tighter standards. But as the number of additional loans has sharply dropped, existing loans remain a risk transmission mechanism to the banks.