The problems at New York Community Bancorp have reignited fears about commercial real estate across the globe.

The commercial real estate market has been in turmoil since the start of the pandemic, and investors remain concerned about the fallout from the slumping value of office buildings and other properties around the world. NYCB flashed a fresh warning sign recently, rattling markets after it cut its dividend and set aside more money than expected for losses on bad real estate loans.

More than $1 trillion in commercial mortgages will come due in the next two years and analysts are concerned about what could happen to other banks that have lent money for commercial buildings, many of which have tumbled in value as borrowing costs climbed.

But how worried should the average investor be about the situation? Most tend not to have too much exposure to commercial real estate in their portfolios, but concerns are mounting about broader problems in the market that could trickle down to Main Street.

Why Now?
Four years after the start of the pandemic, it may seem strange that Covid-era strains in commercial real estate are resurfacing. But the nature of the sector has set the stage for a slow-moving crisis. Commercial property valuations can take a long time to adjust to shifts in demand, and mortgages take years to mature. In the meantime, interest rates have risen dramatically, making it challenging for building owners to refinance debt.

The basic problem? The banks hold debt on buildings that are no longer worth what they were just a few years ago, but no one is exactly sure which loans might unravel. And even as stocks trade at all-time highs, there is looming concern that commercial real estate distress could derail the US economy.

NYCB shares rallied on Friday, but prior to that the stock had plunged in recent days, with the slump pulling down shares of other lenders. Moody’s downgraded the bank’s credit rating to “junk,” while other banks around the world with US commercial real estate exposure hit headwinds, from Aozora Bank Ltd. in Japan to Deutsche Pfandbriefbank in Germany.

Worst-Case Scenario
Most mom-and-pop investors tend to have little exposure to commercial real estate in their 401(k)s or other investments, so advisers generally say now is not the time to panic. About 2.3% of the S&P 500 Index is weighted to real estate, while the FTSE Global All Cap Index is weighted about 3%.  The bigger problem would be bad commercial property debt pulling down banks.

“However, as we saw in 2008, financial institutions are tightly intertwined,” said Michael Becker, partner at Toberman Becker Wealth in St. Louis. “The effect of further credit events in the commercial real estate market would spill over into many other sectors.”

In one worst-case scenario, that could create a risk-off sentiment in the markets, Becker notes. That could stem what has been a lucrative run for markets, with the S&P 500 up more than 20% from a year ago, while the NASDAQ has surged more than 40%.

“Our advice to clients is to contain that risk within their equity portfolio where they can,” Becker said. “If you have known withdrawals or expenses coming, US Treasuries or AAA-corporate paper is the best way to protect against a market contagion.”

Regional Bank Redux
Some of the turmoil links back to last year’s regional banking crisis, with the failures of Silicon Valley Bank, First Republic and Signature Bank. In the wake, NYCB acquired parts of Signature, which increased its size and has since subjected the bank to tougher regulation. Also connecting now to then is the fact that regional banks’ assets are much more concentrated in commercial real estate lending. Such loans account for 28.7% of assets at small banks, compared with just 6.5% at bigger lenders.

Advisers say that, like last year, it’s worth it for consumers who bank with regional lenders to make sure their deposits are FDIC insured.

“Their balance sheets are smaller so they might not be as well diversified as some of the larger banks,” said Dana Menard, founder of Twin Cities Wealth Strategies in Minnesota. “I always recommend to people that if they have any qualms with a certain bank, to diversify not just their portfolio but the banks they use as well.”

The FDIC insures up to $250,000 “per depositor, per insured bank, for each account ownership category.” Given that, if you’re married, you can get $1 million of FDIC coverage by having a personal bank account in your name, a personal bank account in your spouse’s name and a joint account.

It’s not just bank stocks under strain. Some real estate investment trusts (REITs) have tumbled lately as the commercial property sector hits headwinds. But advisers say most diversified investors shouldn’t have too much exposure to contend with.

“REITs generally only consume a small percentage of major diversified indexes like the S&P 500,” notes John Boyd, founder of MDRN Wealth in Arizona. “Of the REITs in the index only a fraction are companies heavily involved in commercial real estate. Even with those companies heavily involved in commercial real estate, not all commercial real estate is the same.”

Bargain Hunters Beware
The contrarian take on the current crisis is that it is a buying opportunity. Regional banks rallied late last year, and the thinking goes that the slump in regional bank stocks may just be an “overreaction.”

But Joseph Boughan, a financial planner at Parkmount Financial Partners in Scituate, Massachusetts, doesn’t like this strategy for individual investors.

“There is little insight into the quality of these companies’ lending portfolios, which is a heightened risk of the sector,” Boughan said. “Buying individual stocks in this sector could still be a minefield as the consequences of the dramatic shift in occupancy from Covid are still trickling through to the bottom lines.”

This article was provided by Bloomberg News.