Financial disaster is looming for American commercial real estate. Here's what experts see happening next.

• Experts have been increasingly sounding the alarm over US commercial real estate.
• Those woes could also spill over into the banking industry, which is heavily exposed to the sector.
• Here are four red flags Wall Street sees in the commercial real estate market.

There's a potential financial disaster looming over America's debt-stricken commercial real estate sector, and a boiling point could come as soon as next year, real estate experts warn.

Markets have been jittery over the commercial real estate since early 2023, when the collapse of Silicon Valley Bank raised concerns about the $1.5 trillion of debt in the sector that's approaching maturity. 

Alarms for the industry have grown louder under the specter of higher-for-longer interest rates. Defaults and delinquencies look to be on the rise. Meanwhile, property values are continuing to plunge, particularly for office buildings slammed by persistent work-from-home trends. 

Here are four things experts see ahead as the commercial real estate sector faces its reckoning:

1. Slumping office prices 

Office property prices are set for another 20% decline in 2024, according to a recent estimate from Capital Economics, which cited weak growth and still-elevated interest rates.

"Though new supply is slowing, contracting demand continues to be the main driver of rising vacancy, which we think will continue for another couple of years," it said in a note.

The firm predicted a peak-to-trough decline of 43% in the US office market, warning that it could take two decades or more before property values return to their early-2020 peak.

2. Bank losses

Banks could lose around $160 billion from commercial real estate, which makes up about a quarter of the average lender's assets, according to a recent working paper from the National Bureau of Economics.

Other market commentators, like hedge funder Kyle Bass, have predicted losses as high as $250 billion.

"It's one asset class that has to get redone, and redone meaning demolished," he said earlier this year about underperforming office buildings.

Big banks like JPMorgan, Goldman Sachs, and Capital One are already trying to dump risky assets from their commercial real estate portfolios, Bloomberg previously reported. Some, however, are having trouble securing buyers, and are trying to hold out for a better deal, it added.

3. Rising defaults

Around 14% of all commercial real estate properties are already in a state of "negative equity," meaning the value of the building is less than the outstanding debt, and 10%-20% of all commercial real estate loans could default, NBER paper added. That's on the low-end of what the default rate was estimated to be during the Great Recession.

Late payments on commercial real estate loans are already starting to pile up, with the office loan delinquency rate hitting 5% this year, according to the data provider Trepp.

Meanwhile, commercial real estate debt overall jumped $37 billion last quarter, according to the Mortgage Bankers Association, largely due to accrued interest on outstanding loans. 

"A decline in sales transaction and refinance volumes has meant less new debt being extended, but it also means that fewer loans are paying off than in many earlier periods," MBA said.

4. 'Zombie' offices

Office buildings could soon be abandoned as work-from-home trends continue to take hold, according to a recent Treasury Department paper, which said some commercial real estate properties could face the same fate as "zombie" malls did during the pandemic.

Some malls were later converted into warehouses, distribution centers, or mixed-use spaces. More creative conversions included a cricket stadium, a police precinct, and a cannabis farm.

"There are striking similarities between the CRE office sector today and regional malls before their consolidation, and there is mounting evidence that CRE could experience a similar decline," the paper added.