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Commercial real estate is a factor in financial stress test

Maryland developers may have heard that the Federal Reserve is using commercial real estate as a measure of how the largest United States banks would perform if another financial crisis should occur. The annual stress test has certain criteria that must be met, and the banks that have outstanding loans have until April 5, 2017, to submit their results.

The test involves a scenario in which the country's unemployment rate quickly spikes to 10 percent, stocks fall and major global economies are battling significant declines in output. The imaginary crisis is more severe than the scenario provided in 2016, and it adds a larger decline the prices of commercial real estate. The first stress test was conducted during the aftermath of the 2008 financial crisis to confirm that banks had enough capital to be solvent.

Banks have already been spurred by low interest rates towards long-term investments, such as multifamily housing and commercial properties that can yield higher returns. There is concern among bank regulators about how exposed the industry is to the loans and that banks are not being stringent enough with their underwriting standards.

In fact, commercial real estate has been flagged as a risk by the Office of the Comptroller of the Currency. The concern regarding the high rates of commercial real estate investment is so great that if the banks participating in the test cannot prove that they can overcome the hypothetical decline, the Federal Reserve may suspend payouts to investors or freeze bank investment plans until the institutions can increase their capital reserves.

This could obviously have an effect on commercial real estate developers who have projects on the drawing boards. If their traditional sources of financing are forced to cut back on their activities, they may want to meet with their attorneys to discuss alternative strategies.

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