Navigating the new normal: Key strategies for banks in the evolving CRE landscape

In today’s commercial real estate (CRE) market, the only constant is uncertainty – and banks are feeling the pressure. 

The profound shifts we’ve been seeing in this sector are forcing banks to rethink how they assess risk, value assets and structure deals. Yield curve volatility, uncertainty around the market values of properties and evolving examiner expectations for bank risk management demand an empirical, multi-scenario approach to managing existing CRE portfolios and keeping originations open for new deals. Adjusting CRE strategies is a difficult task in isolation, but market conditions leave bankers with multiple competing rebalancing activities across their balance sheets. To remain competitive and maximize profitability, banks must create a consistent view of risk across their customer lifecycle—leveraging advanced portfolio monitoring, real-time risk analytics, and multidisciplinary collaboration to adapt to these shifting conditions.

Moody's recent Work from Where documentary explores the evolving CRE landscape, offering a deep dive into the steps investors and lenders can take to monitor risks, uncover opportunities, and build resilience. By leveraging our data, analytics, and expertise, financial institutions can uncover gaps in traditional approaches, gain actionable insights and make faster, more confident decisions. Moody’s integrated approach to risk helps institutions unlock potential at every stage of their customer lifecycle – managing individual customer relationships, overseeing a portfolio, or setting future strategies. With a strong focus on operating leverage, we empower banks to streamline workflows, enhance collaboration, and optimize resources – allowing teams to achieve more with less. By strengthening resilience and adaptability, institutions can proactively measure risk, navigate uncertainty, and position themselves for sustainable growth.

Let’s take a closer look at the key challenges in today’s CRE market and how banks can harness expertise to enhance decision-making, build agile risk management strategies, and drive long-term profitability.
 

Challenges

Banks are undergoing a deep reassessment of their CRE portfolios, asking tough questions about which exposures they can afford to keep in a rapidly changing market. They’re now facing a range of challenges that make lending and risk management more complex. Rising interest rates and loan repricing are putting pressure on borrowers and lenders alike, while market volatility and inflation create uncertainty around property valuations. At the same time, evolving expectations from regulatory examiners are reshaping how banks manage their portfolios and assess risk. Navigating these challenges calls for a strategic approach, balancing risk exposure with the need to maintain strong customer relationships and sustainable lending practices.

“Thinking about the office market, we’re kind of in this Bermuda triangle of uncertainty. We’ve got three major components in any analysis of an office building today that our customers are doing. First is fundamentals – What are the rents in this building? How are my tenants looking? Is office in this market sustainable in the long-term? Then we’ve got return to office— So what kind of tenants are they? Are they law firms and financial firms? Even there, that doesn’t necessarily equate to higher rents or more income for me as the borrower or the owner. And then you’ve got the major boogey-man which is interest rates.”  

 – Joe McBride, Senior Director, Commercial Real Estate Data Products, Moody’s Analytics

Rising interest rates and loan repricing

The current interest rate environment presents profitability challenges for both borrowers and lenders. Borrowers with fixed-rate loans approaching maturity are facing a much tougher refinancing landscape, with limited availability of new fixed-rate loans at significantly higher costs.  As a result, many are turning to adjustable-rate structures, often with hedging strategies like swaps to manage interest rate risk. Volatility along the yield curve has increased both rates and the cost of hedging strategies. For banks, the issue extends beyond borrower difficulties – many pre-rate-hike loans are now unprofitable, as funding costs have risen above loan yields. At the same time, banks are reluctant to issue new fixed-rate loans, fearing further rate increases. Since bank liabilities reprice more frequently than their loan portfolios, compressed margins remain a key challenge, forcing the market to adjust to the disconnect between low-rate legacy loans and today’s higher-rate environment.

Market volatility

Inflation remains a persistent challenge, directly impacting the operating costs of commercial properties and shaping the Federal Reserve’s policy decisions. While price increases have slowed compared to previous years, inflation is still running above target, making it unlikely that long-term interest rates will decline anytime soon. The Fed remains more focused on controlling rising prices than reacting to minor shifts in unemployment, which means borrowers and investors must prepare for prolonged higher rates. Although many expect fewer rate cuts soon, there’s even a possibility that rates could rise again, adding further uncertainty to an already complex CRE landscape.

Evolving regulatory expectations

Banks are grappling with a multitude of challenges brought on by an evolving regulatory landscape. The collapse of banks like Signature Bank, Silicon Valley Bank, and First Republic Bank in 2023 has led to heightened regulatory scrutiny of multiple risk management functions. Banks with high CRE concentration are particularly susceptible during economic downturns and must navigate increased regulatory pressures while maintaining strong customer relationships and sustainable lending practices. In this complex environment, having an empirical understanding of risk – under both current conditions and a range of future scenarios – has become essential. While middle market and community banks were historically hesitant to invest in these capabilities, the ability to model and manage risks effectively is increasingly critical. Banks that made the investment have recognized substantial ROI not only in their regulatory relationships, but also for unlocking multidisciplinary insights that can enhance decision-making. As banks weigh these investments against other strategic priorities, the need for robust CRE portfolio management has never been more pressing. 

Key takeaways

1. Build a multi-scenario playbook and know when to switch plays: Investors are advised to prepare for various economic scenarios and reassess their portfolios to ensure resilience. Banks should support their clients in this process by providing insights and strategies to navigate ongoing market volatility. Proactively anticipating risks before they become apparent is crucial. Banks should use actionable insights to make informed decisions about their portfolios, understanding market trends and tenant behaviors to mitigate potential issues.
2. Be honest about your portfolio and embrace the new financial landscape: Rather than waiting for a return to pre-pandemic conditions, banks should realign their strategies to respond to the new normal. This involves being flexible and responsive to changing market dynamics—property net operating income and valuations are finding a level post-pandemic. That level will be influenced by economic normalization around higher for longer rates. Robust portfolio monitoring using advanced monitoring tools and a wide array of data sets play a crucial role in this adaptation, allowing banks to track risk exposures, identify early warning signals, and make data-driven decisions.
3. Stay informed on regulatory changes: Changes in the regulatory landscape are influencing how banks manage their portfolios. Staying updated on these changes and understanding their implications can help banks focus on loan sales and credit quality effectively. The recent change in administrations may have significant implications for the regulatory landscape through updated rulemaking and enforcement priorities.
4. Leverage emerging technologies for better decision-making: Utilizing generative artificial intelligence (GenAI) and other advanced technologies can enhance analytical capabilities, allowing for better data synthesis and trend analysis. This is particularly valuable in uncertain environments where traditional methods may fall short.

As the CRE landscape evolves at a rapid pace, banks must evolve with it. Clarity on a range of outcomes provides an edge in uncertain markets. Bankers and investors who embrace a proactive, data-driven approach will be the most agile in navigating the shifting terrain. By staying ahead of interest rate fluctuations, adapting to economic shifts, and leveraging cutting-edge technologies, banks can transform these challenges into opportunities.

Rather than simply reacting to market disruptions, banks have an opportunity to redefine their role in the CRE ecosystem – becoming strategic partners that help borrowers and investors thrive in this new reality. The road ahead may be complex, but with the right insights, agility, and innovation, banks can not only manage risk but unlock new avenues for growth in the ever-changing world of commercial real estate.

Interested in learning more?

Discover how Moody’s combines advanced analytics, GenAI, and market insights to help streamline CRE lending processes, enhancing decision-making and risk management.