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Office space demand weak despite return-to-office mandates

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Lenders extend loans, but hawkish Fed may upset plans

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Forecast for loan-loss provisions to rise in 2026

By Niket Nishant and Manya Saini

Nov 6 (Reuters) - U.S. regional banks' commercial real

estate loan books are proving broadly resilient despite worries

sparked by a handful of soured loans, but the office sector

continues to be a pain point, analysts said.

At least eight mid-sized and regional U.S. banks reported

lower non-performing loans (NPLs) - loans on which borrowers

missed scheduled payments - in their CRE portfolios in the third

quarter compared with a year ago, a Reuters analysis of earnings

reports showed.

Commercial real estate, mainly office loans, have been under

pressure since the COVID-19 pandemic overhauled working habits,

and return-to-office mandates have not yet translated into a

meaningful rebound in office real estate demand.

Nearly a dozen lenders said they have reduced their

concentration of office loans. Flagstar Bank, formerly

New York Community Bank, whose CRE troubles sparked a

sector-wide crisis of confidence last year, reduced its

allowances for credit losses tied to its office portfolio by 142

basis points in the third quarter.

Regions Financial ( RF ), meanwhile, said office loans drove

its third-quarter charge-offs, though it expects to resolve

those exposures soon.

M&T Bank ( MTB ) also said it plans to continue trimming its

office loan portfolio, while Citizens Financial said its

office balance declined modestly in the third quarter.

Office property loans are falling behind at record levels,

with more than 11.76% now delinquent, data from Trepp showed.

"There is a profound change in the way people work. Office

vacancy rates are higher than they were even post the global

financial crisis. We definitely haven't worked through all of

the office issues," said Thomas Mason, principal analyst at S&P

Global.

The challenges are more acute for regional banks which have

a higher proportion of CRE loans on their books compared with

the global lenders.

Investor fears over regional banks' CRE exposure were

reignited last month when fears of a trouble in the credit

markets sparked a selloff across the sector.

Lenders have been buying time by extending loans and hoping

that interest-rate cuts by the Federal Reserve will ease

pressure on borrowers, but it is unclear how long that strategy

can last with a December cut now in doubt.

CRE loan pricing tends to follow longer-term Treasury yields

rather than short-term policy rates, which means Fed rate cuts

take time to filter through.

Even with two cuts since mid-September, new CRE loans issued

in 2025 will carry an average interest rate of 6.24%, compared

with 4.76% on loans that mature this year, according to S&P

Global.

Roughly $936 billion of U.S. CRE mortgages are set to mature

next year, 18.6% higher than in 2025, with maturities expected

to peak at $1.1 trillion in 2029, according to S&P Global Market

Intelligence estimates.

"Approximately one-fifth of all maturing commercial real

estate loans in 2025 are expected to be office loans,"

Ermengarde Jabir, director of economic research at Moody's

Analytics told Reuters.

"Property types like office have yet to 'recover' and are

still posting increasing vacancy rates," she said.

BIOTECH REAL ESTATE PAIN

While office remains the industry's pressure point,

landlords and lenders are tightening terms for life sciences

real estate as biotech funding slows and fewer companies in the

sector are able to tap public markets.

"A lot of companies, especially small and mid-sized

biotechs, have put expansion plans on hold," said Vikram

Malhotra, senior equity research analyst at Mizuho Americas.

"These tenants typically operate with four to six quarters

of cash runway, but after missing a fundraising round or two,

some are running out of money."

The overall lab vacancy rate across the top 13 life sciences

markets in the country rose to 22.7% in the second quarter, up

1.2 percentage points from the previous quarter, CBRE data

showed.

BANKS STILL DEEP IN CRE

While commercial banks have scaled back CRE lending and sold

off portfolios to private credit firms, they still held the

largest share of commercial or multifamily mortgages at 38%,

totaling $1.8 trillion, according to second quarter data from

the Mortgage Bankers Association.

Provisions for loan losses in 2026 could rise to 24% of net

revenue, compared with 20.8% this year, wrote Nathan Stovall,

director of financial institutions research at S&P Global in a

note.

"Banks have arguably benefited from private credit firms

growing their market share in CRE. But the industry is not

completely out of the woods," he wrote.