Commercial real estate prices could crash 40% from their peak in a worse disaster than the financial crisis, Morgan Stanley strategist warns

• Commercial real estate may suffer a worse crash than 2008, warns Morgan Stanley Wealth Management.
• Prices could drop up to 40% from their peak as hybrid working and higher interest rates bite.

Commercial real estate prices could plummet as much as 40% from their peak in a worse crash than the 2008 financial crisis, according to Morgan Stanley Wealth Management's chief investment officer.

The grave outlook is based on a raft of headwinds buffeting the commercial real estate sector, including the work-from-home trend and higher interest rates making it harder for investors to refinance a mountain of looming debt.

"MS & Co. analysts forecast a peak-to-trough CRE price decline of as much as 40%, worse than in the Great Financial Crisis," Lisa Shalett said in the weekly Global Investment Committee note.

"More than 50% of the $2.9 trillion in commercial mortgages will need to be renegotiated in the next 24 months when new lending rates are likely to be up by 350 to 450 basis points," she added.

Shalett flagged an outsized risk to regional banks, given small and medium-sized banks hold 80% of US commercial real estate debt outstanding.

High borrowing costs and tighter credit conditions caused by the banking turmoil could raise hurdles for big real estate investors as they seek to refinance a pile of loans. Nearly $450 billion in commercial real-estate debt is due to mature in 2023, according to data cited from Trepp by JPMorgan.

The Federal Reserve has raised benchmark interest rates to upwards of 4.75% from almost zero 12 months ago — the steepest jump in US borrowing costs since the 1980s.

On top of that, hybrid and remote working trends since the breakout of COVID-19 have dampened consumer appetite for office spaces – and that's weighing on real estate valuations.

That could not only hurt building owners and their lenders, given their large loan exposure, but also "interconnected business communities, private capital funders and owners of any underlying securitized debt," Shallet notes.

"The tech and consumer discretionary sectors will not be immune," she added.