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**Rising Interest Rates and Lower Demand Expose Commercial Real Estate Crisis**

The commercial real estate market is currently facing a slow-motion crisis due to a combination of higher interest rates and decreased demand for office space following the Covid-19 pandemic. John Fish, head of the construction firm Suffolk and chairman of the Real Estate Roundtable, discusses the challenges this sector is encountering. In this article, we will summarize the highlights of Fish’s conversation, including the dangers of rising interest rates and the potential impact on the regional banking system.

**The Double Whammy: Occupancy Down, Costs Up**

Fish highlights the significant impact of higher interest rates on large structures, particularly in cities like New York. With almost a hundred million square feet of vacant office space, the situation is alarming. Currently, occupancy rates range from 45% to 65% depending on the location. However, the cost of capital to support these buildings has nearly doubled. This double whammy effect brings down property values, reduces income, and increases capital expenses. Consequently, the timing of these challenges significantly affects the development industry.

**Price Discovery Paralysis and Frozen Capital Markets**

A major problem arising from the crisis is the national freezing of capital markets. This freeze occurs because there is a lack of understanding regarding property values. Due to limited asset trading, market players are unable to evaluate prices accurately. Without clarity on where the bottom lies, it becomes difficult to navigate through the crisis. However, there is a glimmer of hope. The OCC, FDIC, and other federal associations released policy guidance to the industry in June. This guidance demonstrates government leadership on the issue and provides direction and support for both lenders and borrowers. It aims to encourage price discovery by allowing qualified borrowers with quality assets to work with the government to recreate the once-existing property value. The government offers an 18- to 36-month extension for this purpose.

**Regional Banks at Risk: A Need for “Extend and Pretend”**

The term “extend and pretend” has been used to criticize the Fed’s approach to solving the crisis. However, Fish argues that this approach is necessary to prevent potential systemic problems in the regional banking system. Considering the impact on suburbia USA and the significant amount of real estate debt held by regional banks, it is crucial to provide an opportunity for good borrowers with valuable assets to go through a workout. While the SIFIs (systemically important financial institutions) have a small allocation of real estate debt, regional banks have a much higher exposure, with some holding up to 40% of their book in real estate. Thus, the guidance from the government provides a lifeline for the regional banking system.

**Unintended Consequences and the Stability of Main Street**

Fish emphasizes the importance of not underestimating the impact of the crisis on the overall economy. The collapse of regional banks can have severe unintended consequences. When real estate values decline, it affects 70% of all revenue in cities across America. Foreclosed buildings lead to a decrease in financial activity, resulting in reduced tax revenues. This decline in revenue has a direct effect on essential services such as fire departments, police, and education. It is crucial to proceed with caution to maintain stability in the face of this unprecedented crisis.

In conclusion, the commercial real estate market is grappling with the effects of rising interest rates and lower demand due to the pandemic. The combination of decreased occupancy rates and increased capital expenses poses significant challenges for the industry. However, government policy guidance offers potential solutions by allowing qualified borrowers to work out their assets and recreate their value. It also provides a lifeline to regional banks heavily exposed to real estate debt. Avoiding systemic problems in the banking system is crucial to ensure the stability of the overall economy and essential services in Main Street, USA.