The Federal Reserve's biannual Financial Stability Report offers valuable insights into commercial real estate and its relative size compared to other asset types, which Trepp has analyzed. The report employs a four-part monitoring framework to assess the financial system's vulnerabilities and potential shocks.
The framework first examines valuation pressures, which occur when asset prices are high relative to economic fundamentals and historical norms. Trepp specifically highlighted equities, corporate debt, and residential real estate as areas of concern in this regard. Next, it considers borrowing risks, noting that while business leverage remains high and household debt moderate, auto and credit card delinquencies have increased compared to pre-pandemic levels.
Financial system leverage is the third component, assessing institutional ability to absorb losses during adverse shocks. Although banking levels are generally sound, market-adjusted capital levels remain sensitive to interest rates. Lastly, the framework evaluates funding risks, which can expose banks to risk if conditions prompt rapid withdrawal of deposits. Currently, these risks are low due to banks maintaining high levels of liquid assets, and uninsured deposits have decreased.
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As of the fourth quarter of 2024, equities emerged as the largest U.S. asset class, valued at $64.38 billion. Residential real estate followed closely at $59.77 billion, with Treasury securities at $26.90 billion and commercial real estate at $21.83 billion. Investment-grade corporate bonds, farmland, high-yield or unrated corporate bonds, and leveraged loans collectively amounted to $14.36 billion.
Commercial real estate valuations experienced a significant decline in 2024, with a -10.8% year-over-year change. This stark decrease contrasts sharply with other asset classes. Equities, for instance, showed robust growth with an 8.7% annual average growth from 1998 to 2024, a five-year compound annual growth rate (CAGR) of 12.6%, and an impressive 20.5% year-over-year growth.
Treasury securities also performed well, with an 8.4% annual average growth, 11.1% CAGR, and 8.6% year-over-year growth. Investment-grade bonds demonstrated steady performance with 7.9% annual average growth, 5.9% CAGR, and 6.2% year-over-year growth. Residential real estate maintained a solid position with 6.4% annual average growth, 9.9% CAGR, and 6.0% year-over-year growth.
The decline in CRE valuations can be attributed to higher interest rates, tighter credit conditions, and slowing rent growth. The Trepp Property Price Index revealed that by the end of the third quarter of 2024, the benchmark had decreased by 5.9% year-over-year and 12.6% since June 2022 on a value-weighted basis. It's worth noting that these figures differ from the Federal Reserve's data due to varying sources, underscoring the complexity of assessing real estate market trends.
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