We are now starting to see the impact of extended high interest rates. For those that have floating rate loans, they are already feeling the pain. For those with fixed rates loans, as they come due it is becoming harder and more expensive to refinance. Both are feeling the sting of lower property valuations.
But even with the downward pressure on price, many sellers are not budging. In their earnings report last week CoStar’s CEO Andy Florence explained that this was affecting the performance of their online commercial property auction marketplace Ten-X. “We continue to see tremendous transaction interest in the platform in the third quarter, as we reviewed $4.8 billion in potential assets for sale in the quarter,” he said. “Unfortunately, bid-ask spreads remain at high levels, leading to only 35 percent of these potential assets moving through to auctions on Ten-X in the quarter.
Currently, over $80 billion in loans are considered “distressed.” Another $215 billion is at risk of being distressed in the coming months. To no one’s surprise, the majority of those distressed loans are on office properties, where $32 billion are distressed. Compare that to only $7.5 billion worth of multifamily loans that are considered distressed. But while office buildings might currently have the most distressed loans, it could be overtaken. Around $50 billion of office loans are at risk of being distressed while $75 billion of multifamily loans are in the same position. This might be due to the low cap rates that many multifamily buildings were being traded at leading up to and during the pandemic. For the first time, urban areas contributed to more distressed office loans than suburban ones.
It has been rather widely reported that $900 billion of commercial real estate loans are set to mature through the end of next year. But that number does not tell the entire story. A little less than half of those loans ($400 billion) are commercial mortgage-backed securities (CMBS), collateralized loan obligations (CLO). That means that large banks like JPMorgan, Deutsche Bank, Goldman Sachs, and Wells Fargo are on the hook for a lot of potential losses. As bad as that is for those institutions, it represents a bit of good news for regional banks, who have been of great concern after the bank closures that occurred earlier this year.
There will be some pain in commercial real estate if rates stay this high. But that pain will not be shared equally. Offices, particularly urban offices, will be at risk, many of which have been securitized in larger portfolios. As we saw in 2008 mortgage back securities create a diversification that can shelter them from risk. But there is a tipping point. If too many loans in a portfolio become distressed it could take down the rest of the properties they have been packaged together with. You can divide risk up into a larger basket of securities, but you can never truly eliminate it.
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Clean and green
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The Empire Outlets mall in Staten Island costs around $350 million to develop. This week it was bought by Goldman Sachs Urban Investment Group at a foreclosure auction for only $10 million.
Don’t call it a comeback
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Lending in the shadows
The Chinese real estate crisis seems to have been averted, at least for now, but it still brings into questions the viability of the country’s “shadow banks.”