US Commercial Real Estate Credit Distress on the Rise
The pain in US commercial real estate credit continues to bubble to the surface after a surge in borrowing costs and the rise of work from home left lenders vulnerable to losses. Delinquencies continue to increase, though the rate has moderated, researcher Green Street said this past week. Distress is also climbing, rising 23% to more than $116 billion at the end of March from a year earlier, data compiled by MSCI Real Capital Analytics show. That’s the highest in more than a decade.
Investors including Victor Khosla of Strategic Value Partners LLC have warned that debt maturities will lead to a “tsunami” of problems for US offices in particular. There are signs that this is spreading. The past-due and nonaccrual rate for commercial real estate portfolios reached the highest since 2014 earlier this year, the Federal Deposit Insurance Corp. wrote in a report last month, citing multifamily as an increasing source of pain. Past-due and nonaccrual loans are so far past due that banks have stopped booking interest owed because they doubt they’ll ever receive it.
Policy uncertainty, meanwhile, is also holding back activity in the underlying market as businesses delay decisions across districts, the Federal Reserve noted in its May Beige Book survey. For example, some of the reserve banks stated that demand for warehouses was affected by the potential impact of tariffs. The proposed Section 899 ‘revenge tax’ in President Donald Trump’s tax-and-spending bill could also “trigger wider foreign investor pullbacks, impacting all US real estate lenders,” said Harsh Hemnani, a senior analyst at Green Street. German commercial property lender Deutsche Pfandbriefbank AG announced this past week that it’s quitting the US market and will wind down, securitize, or sell its €4.1 billion ($4.7 billion) portfolio there, warning it could make a loss this year due to the expected cost of the decision.
Still, “the timing of the exit likely indicates a belief that current market conditions offer a favorable window for divestment” amid improved liquidity and competition in the debt market, Hemnani said. That’s in part because direct lenders have been raising more capital to invest in CRE, a trend that’s causing some wariness. On Thursday, the Financial Stability Board cautioned that shadow lending to the industry globally “may amplify and transmit shocks to banks.”
Some traditional lenders continue to kick the can down the road in the US rather than take impairments. The wall of CRE debt continues to rise, in part because some credit providers have extended the duration of loans, the Mortgage Bankers Association said on Tuesday. Another headwind for traditional lenders is large unrealized losses on securities portfolios that they’re holding to maturity or seeking to offload, with the FDIC saying last month that the losses stand at more than $410 billion. CRE is likely to be a similar source of pain. Loss rates on commercial and residential mortgage-backed securities suggest the unrealized losses on banks’ mortgage books are likely to be as large or larger than in securities, academics including Lawrence White of New York University’s Stern School of Business wrote last week.
