Commercial real estate lending was a key driver of growth at many banks during the first half of the year as investors and landlords took advantage of low interest rates. Those days could soon be over.

Many bank executives across the country expect demand for commercial mortgages to slow. The main culprit, they say, is rising rates. Some bankers say they have already begun to see a dwindling number of credit applications in July in their loan pipelines, a term used to describe loans still in the underwriting process but not yet closed.

“Our current CRE pipeline is meaningfully lower than what we had in the second quarter,” Kevin Kim, CEO of Hope Bancorp, said during the Los Angeles-based bank's earnings call last week. Hope's commercial real estate loan portfolio rose 15% to $522 million in the second quarter compared to the same time a year earlier.

Total U.S. commercial lending and borrowing is expected to fall 18% to $733 billion this year from last year, according to a July forecast from the Mortgage Bankers Association. Multifamily lending is expected to drop to $436 billion this year, a 10% decrease from last year’s record of $487 billion.

"We expect that the rise in rates, ongoing uncertainty about supply and demand balances among some property types and concerns about the direction of the economy will suppress new loan originations," said Jamie Woodwell, the MBA's vice president for commercial real estate research, in a statement.

However, the MBA anticipates a rebound in 2023 to $872 billion in total commercial real estate lending and $454 billion in multifamily lending — if the U.S. doesn't enter a recession.

"Should the economy enter a recession ... commercial and multifamily borrowing and lending would likely be further constrained,” Woodwell added.

The insight comes as most of the largest U.S. banks and commercial real estate lenders, including JPMorgan Chase and Bank of America, have already reported earnings for the second quarter. Hundreds more banks are scheduled to issue earnings in the coming weeks. Regional banks and community banks are often more likely to discuss commercial real estate lending because it’s a bigger portion of their total business. The largest banks derive less revenue and profit from loans for commercial real estate.

Loans on office buildings, shopping centers and warehouses helped propel many banks to profit growth for the second quarter. At Umpqua Bank in Portland, Oregon, multifamily lending rose 34% to $4.8 billion compared to the same time a year earlier. Umpqua’s total commercial real estate lending, including multifamily, increased 17% to $11 billion.

“We had a really strong Q2 in multifamily,” Umpqua President Tory Nixon said during a July 21 conference call. “Some of that is just a result of borrowers getting financing done and in place before this continued rise in interest rates.”

But those rising rates could put the brakes on growth. Soaring inflation has pressed the Federal Reserve Bank to raise interest rates 150 basis points since March. The Fed approved another 75-basis-point hike on Wednesday.

Borrowers are expected to be more cautious on taking out new loans, said Nixon. Umpqua Bank’s pipeline for multifamily loans “is down a bit and for the obvious reasons,” Nixon said.

The possible slowdown is likely to come from both sides of the table. Bankers are more resistant to originate new commercial real estate loans in a rising rate environment, said Richard Murphy, chief lending officer at Rosemont, Illinois-based Wintrust Financial.

“You’re going to see more pressure on [commercial real estate] growth as it’s tougher to underwrite in a higher interest rate environment,” Murphy said during a July 21 conference call.

Rising rates have cut into the values of commercial real estate properties, making it less likely for borrowers to refinance loans, said Darren King, chief financial officer at M&T Bank, which is based in Buffalo, New York.

“You’re not seeing the turnover in properties like you might have under normal circumstances and that will affect the pace of the decline,” King said.

To prepare for possible hard times, some banks have pruned exposure to the riskiest segments of commercial real estate, namely hotels and offices. Executives at Pittsburgh-based PNC, the nation’s sixth-largest bank by assets, are keeping a close watch on the office market.

“There’s a slow burn on office, where we … continue to be worried, we continue to see slow deterioration,” PNC CEO Bill Demchak said during a July 15 conference call.

Credit analysts at M&T Bank reported seeing “no improved performance” in loans to hotels or retail properties.

Still, many commercial real estate borrowers continue to make scheduled payments, even as a potential recession looms on the horizon.

Wells Fargo Bank, one of the nation’s largest commercial real estate lenders, reported “only two basis points of net charge-offs” in the second quarter, Chief Financial Officer Mike Santomassimo said during a July 15 conference call. Commercial real estate loans at Wells Fargo fell 5% to $44.8 billion in the second quarter compared to the same time last year.

Despite problems in specific pockets of commercial real estate lending, M&T’s King said the bank, which has one of the 10 largest commercial real estate loan portfolios in the nation, has not hit the panic button.

“There is nothing that’s flashing red right now that says that there is a big crisis coming in the next several quarters,” King said.