Commercial real estate will be a major risk to the overall health of the U.S. financial sector and the stability of the economy as a “substantial volume” of the existing $6T in CRE loans comes due in the next few years, the Financial Stability Oversight Council said in its annual report.

CRE is the largest loan type among nearly half of U.S. banks, and more than a quarter of banks carry CRE loan totals that are “large relative to the capital they hold,” the report says.

Many of these loans will be difficult to refinance and will need to be restructured or slide into default, resulting in loan losses for lenders, according to the FSOC. As CRE loan portfolio losses accumulate, the problem can edge over to the broader financial system.

The dynamic is self-reinforcing, as loan losses affect property values and vice versa.

“Sales of financially distressed properties can reduce market value of nearby properties, lead to a broader valuation spiral, and even reduce municipalities' property tax revenues,” the report says. “In addition, widespread CRE distress can contribute to tightening credit availability. Banks with high exposures to CRE loans ... may be particularly vulnerable to CRE loan distress.”

The office sector in particular has suffered as demand for its product has remained anemic, but both multifamily and industrial have their challenges as well. Both sectors experienced historic building surges in 2021 and 2022, leading to large construction deliveries this year and into 2024.

At the same time, demand has waned for both product types as the economy has slowed and consumer spending dipped.