The commercial real estate sector is facing growing concerns over mounting debt as it grapples with higher interest rates, a cautious lending environment, and limited activity in terms of office return and leasing due to the lingering effects of the COVID-19 pandemic.
According to analysts at Morgan Stanley, nearly $1.5 trillion in commercial real estate debt is set to mature by the end of 2025. A number of metropolitan areas may encounter challenges in refinancing properties tied to debt in commercial mortgage-backed securities (CMBS) loan portfolios, given the current economic pessimism, according to an analysis by Bloomberg and The National Observer.
Not surprisingly, the major gateway markets are carrying the highest amount of maturing CMBS debt within the next 18 months. New York leads the list with approximately $39.8 billion, followed by Los Angeles ($17.9 billion), Miami ($12.6 billion), San Francisco ($11.4 billion), and Las Vegas (nearly $10.6 billion).
The analysis encompassed all commercial real estate property types financed with CMBS debt and loans that are current on payments, as well as those flagged by loan servicers as distressed. When focusing specifically on distressed loans, including those on loan servicer watchlists, in special servicing, delinquent, in foreclosure, bankrupt, or matured and nonperforming, a similar trend emerges.
New York has 149 distressed CMBS loans with a collective outstanding balance of $2.6 billion. Chicago follows with 79 loans totaling $1.5 billion, and San Francisco with 134 loans amounting to $1 billion.
However, it is important to note that the CMBS market represents only a fraction of the overall commercial real estate distress and maturing loans in a given metropolitan area.
The impending wave of maturing loans is a significant concern for property owners hoping to refinance or sell their assets in a challenging capital markets environment, particularly with reduced interest from lenders, especially for office space. Real estate investors and capital sources, such as private equity firms, have had to adopt a more creative and meticulous approach to deals, particularly as loans near maturity.
According to Trepp LLC, which closely monitors the CMBS market, the CMBS office delinquency rate, which remained relatively low compared to other major asset classes during much of the pandemic, has experienced a substantial increase in recent months. In June, the delinquency rate reached 4.5 percent, compared to 1.86 percent at the beginning of the year.
Retail and hospitality assets continue to exhibit the highest delinquency rates among properties carrying CMBS debt, with retail properties at 6.48 percent and lodging at 5.35 percent in June, according to Trepp. However, the gap between those delinquency rates and the office delinquency rate is quickly narrowing.
An analysis conducted earlier this year by CommercialEdge, a real estate research company based in Santa Barbara, California, revealed that within the next three years, loans will mature on more than 9,500 office buildings, accounting for 17 percent of all U.S. office stock.
Analysts and individuals closely associated with commercial real estate financing have stated that most lenders are reluctant to become property owners, especially for troubled properties such as vacant office towers. This suggests that some degree of “extend and pretend” strategy, where loan terms are extended for properties facing a decline in value instead of initiating foreclosure, will occur. However, certain properties are experiencing significant cash-flow issues that cannot be resolved by delaying the problem.
In fact, some major commercial real estate landlords have made the decision to walk away from underperforming office properties. As a result, more landlords are likely to adopt a similar strategy, as highlighted by Henry Stimler, executive managing director at Newmark Group Inc., who noted that some years ago, walking away from a loan was viewed as a permanent black mark on a company. However, now it has become a trend embraced by prominent players in the industry. Stimler added that if the big players are doing it, smaller landlords are likely to follow suit.
Furthermore, many others are selling their assets for significantly less than their original purchase prices from years ago.
