Wall Street and New York Stock Exchange in New York City's downtown Manhattan.

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At the same time that U.S. banks are saying credit quality is strong enough to release billions in reserves, commercial real estate companies are reporting prices on certain properties have dropped 40% or more. And no market is struggling as much as New York City's Manhattan.

The price declines have been particularly severe in the hotel and retail subsectors. While there is distress, the drastic price declines might not necessarily translate to charge-offs. Debt markets remain open and property owners resilient. With encouraging news on vaccine distribution, market participants said lenders and property owners alike are looking to delay the pain until an economic recovery takes hold.

"There are signs of distress at the property level, but there's a question if it's a permanent or temporary distress situation," said Jim Costello, senior vice president for Real Capital Analytics, a data and analytics firm focused on CRE. "Property owners are looking at the state of play and they understand that in six to eight months, we might be getting back to some kind of normal. ... And they don't have to sell because they can get credit."

But with some companies contemplating permanent work-from-home status for employees, there is a chance that "normal" never comes back.

CRE values turn down

The COVID-19 pandemic has forced employees to work from home, making for empty office space in the urban cores of cities. Simultaneously, work-from-home arrangements and the nature of the pandemic have made the expensive urban centers less attractive to renters and homeowners. Tourism remains a shadow of its former self, as the pandemic has discouraged travel and shuttered attractions that rely on crowds. These dynamics appear to be especially troublesome for New York's urban core, the borough of Manhattan, home to more than 1.5 million people and most of the city's marquee attractions from Wall Street to Broadway to the Empire State Building.

Some properties have shown much more dramatic declines, particularly buildings backing securitized loans that have been sent to special servicing. Trepp LLC, a data company that specializes in commercial mortgage-backed securities, reported that hotel properties across the country posted a 36% decline in appraised values in 2020. Retail properties fared even worse, posting a 42% decline. Trepp's study focused on properties that received a new appraisal between March 2020 and year-end. Properties typically receive a new appraisal when the loan has been transferred to special servicing, so the reported declines likely focus on properties already prone to default, wrote Catherine Liu, an associate manager for Trepp, in an email.

The rise of the suburbs is showing up in valuations. As of the 2020 fourth quarter, apartment properties in Manhattan had lost 17.8% of their value over the last year, compared to a 4.7% gain for New York City's suburban markets, according to a price index from Real Capital Analytics. Commercial properties, which include office, retail and industrial, showed a 10.9% decline in Manhattan. The borough's declines for both apartment and CRE were the largest among the more than 30 markets that Real Capital Analytics tracks in its price indexes, which use same-property sales to track pricing.

Trepp's data show New York City properties have posted even larger losses than the national average. One property, the Shoreham Hotel in midtown Manhattan, received a valuation of $4 million, down 79% from an appraisal of $19 million in 2018. At the time of securitization in 2007, the property was valued at $72 million. Many of the city's most troubled properties such as the Shoreham Hotel were struggling before the crisis. Lenders foreclosed on the Shoreham Hotel in 2017.

Impact on banks

While commercial real estate delinquencies remain low by historical standards, the decimation of values has some analysts concerned.

"It just seems to me that some of these marks are so large that it's going to be impactful to bank earnings or balance sheets," said Frank Schiraldi, an analyst for Piper Sandler & Co. "Longer term, I tend to bet on New York City bouncing back, but it's definitely worrisome in the near term."

Paoli, Pa.-based Malvern Bancorp Inc. has already been stung by New York City's ailing CRE market. The bank partially charged off a New York City CRE loan to the tune of $2.9 million, the company disclosed in January. But a February appraisal came in even lower, forcing the bank to book an additional $3.1 million impairment and delaying its quarterly filing. A bank spokesman declined to comment. Malvern recently hired activist investor Larry Seidman as a consultant. Seidman said in an interview that while he had not yet reviewed the credit, he was not concerned.

"I think that's blown out of proportion," Seidman said. "Everyone said New York wasn't coming back twice already. It came back. It's just a question of how much time."

Gerard Cassidy, an analyst for RBC Capital Markets, said the problems presented by the pandemic will likely prove temporary for New York City. He said tourism should return and the city will remain the premier financial hub, attracting large companies and business travel. However, he said that the persistence of elevated crime and social unrest would present more significant concerns similar to the 1970s when crime played a role in population decline.

Through 2026, New York City metro area's household growth is projected to grow at an annualized rate of just 0.06%, ranking behind Detroit and just ahead of Buffalo, N.Y., according to Claritas, a demographic data provider.

Cautious lending, competitive bidding

A couple of bankers said they are approaching the New York City market with caution but expect to keep issuing or buying loans.

"We intend to be an active lender in that market, but we will be incrementally more conservative than we would have been in the past," said OceanFirst Financial Corp. CEO Christopher Maher in an interview.

Caution on CRE appears to already be taking hold. In 2020, conventional CRE loans carried an average loan-to-value of 66.4%, down from 67.1% in 2019, according to Real Capital Analytics. Northeast Bank buys CRE loans in markets across the country, including New York City. CEO Rick Wayne said some appraisals have shown significant drops in valuation, but there are few distressed loans for sale because credit remains sufficiently available. When the pandemic struck, Wayne said he expected to buy performing loans at a significant discount, similar to the Great Recession. But opportunities have been scant.

"Even nonperforming loans haven't come down that much," Wayne said in an interview. "Part of the reason for that, I think, is that [bond] yields are so low that people in the business of lending or in fixed income are able to get reasonable yields by buying loans now."

With credit still widely available, few properties have been forced into distressed sales. Some analysts also pointed to the ability to delay pain. Real Capital Analytics' Costello said many office properties carry long-term leases, so even if the building is vacant, the property is generating income. Further, extensive government stimulus, including Paycheck Protection Program loans for small businesses, have allowed some tenants to keep up with payments through the crisis.

And regulators have allowed banks to delay the troubled debt restructuring designation for loans that have required some level of modification as lenders and borrowers alike look to ride out the pandemic and its effects. But at some point regulators will transition from a lax attitude to a stringent one.

"I've heard some bankers say they're getting some pressure to consider: 'If I have to sell this, what would the mark to liquidity be?' They're not being told to do it right now, but they're starting to plan around it," Costello said.

And there are plenty of vacancies. In the fourth quarter of 2020, the Manhattan office market vacancy rate reached 15.2%, a 26-year high as new leasing activity reached an all-time low, according to Cushman & Wakefield, a brokerage company. The company's forecast predicts vacancies will increase and net absorption will decline over the next 12 months.

Even as vaccines proliferate, there remains a great unknown question in the CRE landscape: What does the new normal look like? CRE properties tend to be valued based on pro forma rents, an unknowable figure as work-from-home remains the norm. If prices don't bounce back, banks may need to reconsider their reserve releases.

"I don't think that we've felt the impact of the vacancies, nor do I think that we're properly analyzing how the duration of those vacancies will affect values," said Neekis Hammond, a managing director who specializes in stress testing and loan loss reserve analysis for consulting firm Abrigo. "We've had a fundamental shift in the way people work, and a lot of the assumptions about full vacancy need to change."