There's more pain coming for residential and commercial real estate as tight credit and job worries threaten property markets

• Residential and commercial real estate have more pain coming as financial conditions tighten, Wells Fargo said.
• Housing has been slammed by high mortgage rates, which have weighed on both demand and supply.

There's more pain ahead for both the residential and commercial real estate market, thanks to a cocktail of bearish forces that are bearing down on both sectors, according to Wells Fargo.

"Our rating on the Real Estate sector remains unfavorable. Numerous headwinds have combined to make residential and commercial real estate investment unattractive based on our current analysis," senior global market strategist Scott Wren said in a note on Wednesday. "We expect that further deterioration of the underlying fundamentals is likely."

A little over halfway through the year, financial conditions have tightened after a slew of bank crises, interest rates are at their highest level since 2007, and the Fed is saying it still might not be done tightening monetary policy to fight inflation.

The rate on the 30-year mortgage is close to 20-year highs, which has weighed heavily on both supply and demand for homes. Higher rates, meanwhile, have also increased the cost of commercial mortgages and made it more expensive to refinance the mountain of debt coming due in the sector.

But that's not all, Wren said.

Banks are pulling back on lending after the failure of Silicon Valley Bank and others in the spring, which has made credit availability worse for commercial borrowers. The percentage of commercial mortgages that have been delinquent for 30-89 days surged to 1.6% in December, more than double the rate of 0.6% in April 2021. Meanwhile, the delinquency rate for office-backed commercial mortgage-backed securities has surged to a five-year high, Wren said.

In residential real estate, higher rates have led to reduced inventory, as many homeowners are cling onto the lower interest rates at which they financed their homes years ago. The lower supply of homes has pushed up prices even as demand sags because of expensive borrowing costs.

The median price for an existing home in the US surged to $413,800 last month, according to National Association of Realtors data. That's a 51% increase from the median price in December 2019, posing a major headwind for the residential housing market.

"We believe tighter credit and job worries should impact demand. For these many reasons, we are cautious on residential markets," Wren said.

Meanwhile, in commercial real estate, office demand is still way down as work-from-home trends remain popular. Office vacancy just hit an all-time high of 13.1, NAR data shows. The All Equity Real Estate Investment Trust Index has also fallen 13% from levels at the start of the year, a sign that property values are taking a hit.

"We expect commercial real estate to underperform on a relative basis in the near-to-intermediate term," Wren said of the sector.

Experts have warned of trouble in real estate as macro pressures mount. Housing affordability won't likely improve until mortgage rates decline more meaningfully, though that's not expected to happen soon. Meanwhile, commercial real estate prices are in danger of falling dramatically, with Morgan Stanley strategists predicting a 40% peak-to-trough decline.