The commercial real estate market has faced myriad challenges in a host of sectors as the COVID-19 pandemic upended the industry.

Most pointedly, however: office space.

The momentum that had been building in metro Detroit throughout much of the 2010s came to a screeching halt with the onset of the global health crisis. The metro Detroit office vacancy rate was 14.82% at the end of 2019, according to data compiled by the local office of New York City-based brokerage house Newmark. Well off the national rate of 9.41%, but coming off another year of mostly declining quarterly vacancies seen in the leadup to the shutdown.

As office workers were sent home and buildings were emptied during the pandemic, spaces previously bustling with employees were suddenly vacant and many landlords were left in the lurch. Today, the vacancy rate is 22.11% in metro Detroit and 13.45% nationally, according to Newmark.

And when building occupancies dropped, so did their values. Banks in some cases — not all — looked at the sector as increasingly risky, and coupled with higher interest rates to combat inflation, office loans have become more difficult to come by.

Jonathan Gray, president and CEO of Blackstone Inc., said during an address at the NEXUS conference in Orlando, that some failing banks like First Republic ended belly-up because of a “mismatch of assets and liabilities.”

“They had 20-year loans and 20-second deposits,” Gray said, according to a Private Debt Investor story.

But local banks by and large have been more prudent in their lending.

Data provided by East Lansing-based Community Bankers of Michigan shows that nonperforming assets — essentially, loans not being paid — are relatively small. Two-thirds (49) Michigan banks report nonperforming assets comprise less than 0.5% of their loan totals, while the rest report they make up 2% or less of their totals.

Joshua Bernard, principal of Southfield-based Bernard Financial Group, piggybacked on what Gray said, noting that we “can’t necessarily assume that they all made 20-year loans just because they have a lot of real estate exposure.”

“There are plenty of local community banks and regional banks that made good, appropriately termed and credit-structured loans,” Bernard said. “There are obviously some that did not, and time will tell.” 

For local Michigan banks, commercial real estate loans are often for bread-and-butter projects, not splashy high-rise office or residential towers.

For example, Craig Johnson, executive vice president and chief lending officer for Fenton-based The State Bank, said the bank has 48 office loans totaling about $62 million, for an average of just about $1.3 million. There have been no workout arrangements needed on its CRE loans, which account for 48.2% of its $1.74 billion in assets.

“What’s really the concerning sector, which are the larger multi-tenant, non-owner-occupied properties in major metropolitan areas, or in the suburbs of the major metropolitan areas,” Johnson said. “Our exposure in that sector is much smaller. While we do have a couple relationships in multi-tenant, they’re not $30 million or $50 million transactions, or 100,000-square-foot footprints. They are much smaller, much more manageable.”

Like all banks, The State Bank is looking to minimize its risk. The State Bank’s policy for a non-owner occupied real estate loan includes 25% equity on the property and a stringent application.

“There are certain sectors we’ve never touched: land development, spec housing, we’ve never done that,” Johnson said. “Owner-occupied office we would look at, but we’re not looking at any of the non-owner occupied office sector at this point in time.”

Regional banks and community banks have different business models, said Cindy Livesay, executive vice president and chief credit officer of Bank of Ann Arbor, which is why small and mid-sized banks have a reputation for commercial lending.

Bank of Ann Arbor has 16 locations in Southeast Michigan and a commercial real estate lending mix of 44.8% — a percentage that CEO and President Tim Marshall is comfortable with.

“We stay close to our values. We don’t paint any black box that (says) we’re not going to do this or we’re not going to do that,” Marshall said. “We evaluate each individual opportunity on the merits that they present, and we haven’t closed our doors. We’re not going to close our doors, we’re going to continue to support our clients that operate in this space based on the merits of the project that they present. And if it hits our underwriting guidelines we’ll continue to lend money.”

Concerns about commercial real estate lending all circle back to credit quality. Michael Tierney, president and CEO of Community Bankers of Michigan, said credit quality at banks headquartered in Michigan is “very strong.”

“It’s not the value of the real estate that drives whether or not (banks) have a credit issue, it’s the economic viability of the business that you have as a client,” Tierney said. “And the Michigan business category is pretty strong …. Frankly, I’ve been in the business for 47 years and it has never been better than it has been the last couple of years.”

Data from QwickAnalytics State Performance Trends from December 2023 reveals a mixed picture of asset quality. Across all 73 banks in Michigan included in the data, there is about $250 million tied up in nonperforming assets or NPAs.

According to the data, 3%, or $10 million, of nonperforming assets are 90 or more days past due. A higher percentage in this category suggests a higher level of delinquency. Nonaccrual loans sit at 65% or $160 million, indicating a significant portion of loans facing repayment challenges.

However, banks have made efforts to address borrower financial difficulties. 

Restructured loans make up 26%, or $60 million, of the NPA aggregate among Michigan’s banks. OREO, or real estate assets that a bank has acquired through foreclosure or deed in lieu of foreclosure, sits at 6%, or $20 million. A higher percentage of OREO suggests a larger inventory of real estate assets on the bank’s books, which can impact its financial health.

The “fundamental strength of credit quality in CRE has kept delinquency rates in check,” a Goldman Sachs report from June 2023 said. As a result of more stringent lending practices, credit quality may be stronger now than in the years preceding the Great Recession in 2008.

Mark Augustyn, chief commercial banker and co-founder of Mercantile Bank, said the bank has had to learn to withstand different economic conditions, including the Great Recession and the COVID-19 pandemic. Its current CRE mix sits at 36.9%.

Grand Rapids-headquartered Mercantile has had decades to refine its loan portfolio, which Augustyn said has shifted due to downturns in the economy, but has also been defined by the struggles west Michigan communities faced during those periods.

“We formed Mercantile Community Partners, which does construction of low-income tax credit projects, which was something that didn’t exist at that bank, does not exist extensively throughout the market, and it was a need that we saw within the market,” Augustyn said. “It’s helping low-income folks within our communities; it’s bringing new housing to the market and it’s not permanent financing. We’re handling the construction of it and then we’re out a tax credit.” 

Grand Rapids banks, however, have not been impacted the same way banks in other cities have in response to commercial real estate loans failures related to COVID-19 pandemic fallout, Augustyn said.

According to 2023 Census data, Kent County, which houses Grand Rapids, saw an in-migration of 2,434 people between 2022 and 2023. The Grand Rapids-Wyoming-Kentwood Metro Area saw double that at 5,665 new residents.

“San Francisco, New York, Chicago, and these major cities where they saw some flight of people moving out of some of those huge cities, well they’ve been moving to Grand Rapids,” Augustyn said. “Our space is thriving, occupancy is at all time high … certainly the office market has had some challenges, but that’s been a market that we’ve been very, very selective in if we participate.”