While some asset managers believe that we are not in the scale of the 2008 financial crisis, others believe a real estate recession could be in the offing on the heels of a perfect storm of rising interest rates forcing assets to reprice down.
- Rising Defaults: The CRE industry, already shaken by COVID-19 and turbulent banking sectors, is grappling with rising defaults due to rising interest rates, impacting property values and lending standards.
- Big Players Walk Away: Large property owners are walking away from their investments as portfolios no longer meet investor requirements and generate adequate returns.
- Banks Brace for Impact: US banks, once considered resilient to CRE defaults, are now preparing to sell off property loans at a discount to reduce their exposure, reflecting their waning confidence in the market.
In a market already shaken by COVID-19 and turmoil in the regional banking sector, we believe that the CRE industry might be poised for a real crisis the likes of which hasn’t been seen since the ‘90s. Rising interest rates have wrought lower property values, higher borrowing cost and tighter lending standards which has already led to lower loan origination volume and unprecedented slashes in deal issuance.
On the secondary as well as securitized fronts, the news is just as bleak, with even top property owners like Brookfield and Blackstone running for the hills on their existing loan portfolios. Brookfield recently defaulted on more than $750 million of debt in their Brookfield DTLA Fund tied to two trophy office buildings in downtown Los Angeles. Blackstone sent two separate loans on Manhattan office and residential buildings to special servicing, and they are not the only ones.
Losses in private label CMBS are on the rise with several notable office and retail loans being liquidated in the past few months at higher than ever loss severities as can be seen below in the table generated by Yield Book Research. In the last year, two Class A office towers in Houston’s Energy corridor – Two Westlake Park in WFRBS 2014-C24 and Three Westlake Park in GSMS 2014-GC20, had realized losses of 82% and 88% and these are just one of many such examples of troubled trophy office assets in locations such as Houston, San Francisco and Manhattan. More recently, 470 Broadway which was securitized in MSBAM 2012-C6 was liquidated with an even higher loss severity of 93.2%. And to add to the sectors troubles, Multifamily which was hitherto considered a haven of CRE has also begun to show cracks as valuations of apartment buildings fell nearly 15% by the beginning of the second quarter of this year and rising debt costs threaten to wipe out many Multifamily owners across the country.
Non-Agency CMBS Loan Losses in Last 12 Months
|Disposed Amount ($m)
|Disposed Amount with Realized Loss > 0 ($m)
|Realized Loss ($m)
|Loss Severity (For Loans with Loss > 0)
|Percent of Retail and Hotel Disposed Amount
Source: Trepp. Yield Book September 2023
In a list identified by data provider and LSEGH partner Trepp, approximately $7.7 billion of office loans, more than a quarter of which are owned by big-name institutions, are now in special servicing. This begs the question. Why are these powerful landlords and owners just walking away and how will this impact the larger CRE market including lenders and investors alike?
Compared to smaller property managers who have more skin in the game, larger borrowers do not wish to hang on to buildings long term, nor does looming foreclosure seem to be as much of a deterrent. Clearly, they have deeper pockets and more of a willingness to cut their losses given that the portfolios are not generating the kinds of returns they once were and no longer satisfy their investor requirements. Additionally, with rising rates, for large loan floaters with expiring interest rate caps the dramatic increase in the cost of protection through interest rate hedges is a cause for concern.
And what about lenders and investors? Until now, the general belief has been that the ones most negatively impacted by the defaults of these big office towers and multi-family properties were not the US commercial banks but the holders CMBS and specialized CRE lenders. Until now being the key. It looks like the crisis has deepened to the point where we are now seeing US banks bracing for impact as they prepare to sell off property loans at discount to reduce their CRE exposure. Banks like HSBC USA, PacWest and Wells Fargo are off-loading debt at a discount even when borrowers are up to date, a sign of their lack of faith in the once stalwart CRE market.
And to add to the existing woes of almost all the players in CRE, we see a wall of debt scheduled for repayment in the coming years. Almost $1.5 trillion of US CRE debt comes due before the end of 2025. “Refinancing risks are front and center”, for owners of properties from office buildings to stores to warehouses, according to Morgan Stanley analyst James Egan who continues to say, “the maturity wall here is front-loaded. So are the associated risks”. The graph below shows a breakout of the US CRE debt coming for refinance in the next 7 years, rather ominously highlighting that nearly half is coming due in the next 3 years.
47% of U.S. CRE debt maturing between 2023 and 2030 is expected to be repaid in the next 3 years.
With funding becoming more expensive and no revenue to be found anywhere, lenders need higher yield which was traditionally through high interest CRE loans. But with credit becoming more and more of an issue as borrowers demonstrate their willingness to walk away, the big question is, will lenders want to swap their revenue problems for credit problems?
With all these different factors in play, while some asset managers believe that we are not in the scale of the 2008 financial crisis, others believe a real estate recession could be in the offing on the heels of a perfect storm of rising interest rates forcing assets to reprice down.
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