US banks are trying to modify terms of US commercial real estate loans to stave off defaults, abating near-term losses amidst growing stress in the commercial real estate market.
Higher interest rates and a slump in property values in 2023 have made funding challenging for properties and have caused Wall Street’s primary method of financing commercial real estate, commercial mortgage-backed securities (CMBS) to decline. Office values had fallen 12.7% by the first quarter from their peak a year ago, according to Moody’s. About $2.1 billion of office loans pooled in CMBS matured in May, almost double the total amount from January through April 2023. Out of that figure, 36.5% were modified or extended, according to Moody's report.
According to real estate data provider Trepp, some $20 billion of office CMBS loans are maturing in 2023, and more is coming.
"The office sector faces the fiercest headwinds even as some investors are dipping their toes back in on newer, high-quality space," Steve Jellinek, head of commercial mortgage-backed securities (CMBS) research at DBRS said to Reuters. “CMBS special servicers, which handle troubled loans, had a combined unpaid principal balance of $12.74 billion in office loans as of June, up from $5.51 billion a year ago”, he stated.
Deutsche Bank research indicates that CMBS issuance has so far dropped by 83 percent this year to $9 billion. While this accounts for only around 11 percent of the estimated $20.7 trillion US commercial property market, CMBS serves as an essential indicator of the financial health of hotels, office buildings, apartment buildings, shopping malls, and other income-producing real estate. Strategists of PGIM Global Asset Management expect property prices to drop in a range of 7.5 percent-50 percent in this cycle, with office properties likely facing the most downside risk.
Gabe Rivera, co-head of securitized products at PGIM Fixed Income, commented in the report, “Frankly, the machine is shut down. It’s not a great environment.” Interest rates have played a critical role in shaping market conditions for U.S. real estate, with borrowers previously able to take equity out of buildings based on record valuations when financing was cheaper in recent years. However, the recent surge in interest rates, with the Federal Reserve rapidly increasing rates by 500 percentage points in the past year, has made funding challenging for properties in need of financing”.