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What CRE Loan Defaults Could Look Like in COVID-19

National  + Weekender  | 

Mapping out a path through uncharted territory is something of a challenge, and that’s what Trepp faced when it set out to gauge the potential impact of the COVID-19 crisis on commercial real estate loans.

“It is difficult to know which economic and real estate forecast scenario to use,” Trepp says in a new report. “It is possible that the severe disruptions that have been impacting nearly every aspect of daily life will be over as suddenly as they hit, but it is also possible that they will last longer and have a deeper impact on the economy. Even if the disruptions do pass relatively quickly, the linkages within the economy mean that the economic fallout will be with us for some time.”

With some modifications, Trepp based its COVID-19 model on the Severely Adverse scenario that regulators have used for some time in conducting stress tests on banks. Under this scenario, GDP falls precipitously, the unemployment rises to 10%, interest rates plunge and asset prices fall. As a result of the pandemic, “the U.S. economy is already experiencing most of these effects and more are likely to come, though as mentioned above, it is difficult to know how long or deep these impacts will be.”

As the industry has seen already, different property sectors are withstanding different degrees of impact from the shutdown of everyday routines. Multifamily and industrial aren’t feeling much of an impact, while hotels are expected to post significant declines in occupancy and revenue. And while most U.S. offices are empty at present, their occupants are continuing to pay rent.

Accordingly, the default rates Trepp forecasts vary by sector, from significant to not so bad.

Trepp expects defaults on lodging loans to reach a peak of nearly 10% by the end of 2021. Retail defaults will also rise sharply, peaking at 3.6% in late 2021 or early 2022.

“Office default rates will rise, though not as severely,” says Trepp. “The peak default rate for office loans in this scenario would be 0.8%.”

Industrial and multifamily mortgages will experience smaller increases in default rates, peaking at about 0.5%. For both property types, the expected declines in prices and NOI mean that LTV and DSCR ratios will hold up better, when compared to lodging and retail.

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About Paul Bubny

Paul Bubny serves as Senior Content Director for Connect Commercial Real Estate, a role to which he brings 13-plus years’ experience covering the commercial real estate industry and 30-plus years in business-to-business journalism. In this capacity, he oversees daily operations while also reporting on both local/regional markets and national trends, covering individual transactions across all property types, as well as delving into broader subject matter. He produces 15-20 daily news stories per day and works with the Connect team and clients to develop longer-form content, ranging from Q&As to thought-leadership pieces. Prior to joining Connect, Paul was Managing Editor for both Real Estate Forum and at American Lawyer Media, where he oversaw operations at both publications while also producing daily news and feature-length articles. His tenure in B2B publishing stretches back into the print era, and he has served as Editor in Chief on four national trade publications. Since 1999, Paul has volunteered as the newsletter editor of passenger rail advocacy groups (one national, one local).