Report: CRE Distress is Possible; Watch Out for Generalizations
Bank failures and looming commercial real estate debt maturity continue generating concerns. These concerns are justified . . . but.
That “but” comes from a recently released Marcus & Millichap Special Report entitled “Banking and CRE Distress.” Though Marcus & Millichap research experts and report writers Jessica Henn and Luke Murphy don’t downplay the situation, they provide some context to it.
First and foremost, commercial real estate assets are generally performing well, outside of certain challenged segments. As a result, “current CRE distress levels remain low in comparison to historical period of disruption,” the authors point out. In Q4, they said distressed CRE assets made up only 1.2% of nationwide sales volume. In the meantime, 12 quarters following the beginning of the Global Financial Crisis, “distressed sales accounted for 20.3% of the deal flow,” according to the report.
Other aspects noted by Henn and Murphy include the following:
Volume of CRE Maturing Debt isn’t a Systemic Risk
Though reported debt maturities range from $400 billion (MSCI) and $728 billion (Mortgage Bankers Association), at the other end of the equation are increasingly stringent loan underwriting requirements in play since the GFC. Furthermore, “robust rent growth over the term of the loans has provided the owners of most types of CRE with sufficient equity to mitigate default risk,” Henn and Murphy wrote.
But Some Properties Could Be in Trouble
According to Trepp, more CMBS loans fell into special servicing during February 2023, representing 5.2% of total CMBS CRE debt. Downtown offices and other properties undergoing cash-flow challenges could “be predisposed to a distressed sale.” Also under the gun are “borrowers with variable rate debt who did not hedge against interest rate increases with a rate cap,” the research analysts commented. These borrowers could end up with interest payments higher than the assets’ revenue capabilities.
CRE Likely Won’t Create Bank Closures
Yes, banks hold more than half the CRE debt scheduled to mature in 2023. But substantial distress in commercial properties has yet to materialize. “Concern primarily surrounds regional or local banks that might have a more real estate-concentrated portfolio,” the authors noted. “However, much of the outstanding debt originated by smaller banks is not set to mature this year.”
Furthermore, the banks that failed shouldn’t be compared to regional banks that manage real estate-centric portfolios. Silicon Valley Bank handed venture capital related to tech firms. And while Signature Bank did have sizable real estate exposure, it was a “primary lender to the beleaguered cryptocurrency sector,” according to the report.
Finally, Avoid Blanket Generalizations
The authors cautioned against generalizations pertaining to CRE maturities and holdings, pointing out that “the commercial real estate sector spans a wide array of segments, geographies and demand drivers.” Though real assets purchased between 2020 and the first half of 2022 with adjustable rate mortgages and more aggressive underwriting could be in trouble from ongoing Federal reserve rate hikes, “the majority of debt held by banks either has significant equity or years before maturity, making them unlikely to face distress,” note Henn and Murphy.