Next 12 Months Pivotal for Commercial Real Estate Debt Maturities

Article originally posted on CoStar on July 18, 2023

Over the next 12 months, the U.S. commercial real estate sector will grapple with the reality that three-quarters of a trillion dollars in loans are scheduled to come due this year and next. Within the context of $4.5 trillion in U.S. commercial real estate debt, this juncture could be a turning point that shapes the industry for the next decade if it’s not managed successfully.

The implications of a shortfall in refinancing activity could reshuffle lenders’ appetite for commercial real estate and influence their capital allocations in coming years. One common lending source has been the commercial mortgage-backed securities, or CMBS, market, an active player across most property types that accounts for 13% of the total outstanding debt. The office and retail sectors are the most heavily represented within the $636 billion of unsettled CMBS loans, accounting for 27% and 19% of the loans, respectively.

Over the next year, $93 billion of CMBS loans will mature across four key property sectors: office, industrial and hospitality, each with roughly $25 billion coming due, and retail with $17 billion. Fresh capital is increasingly needed to manage these debts, and new loan originations are evaporating due to recent pricing dislocations in the market.

In 2022, CMBS originations totaled $70.2 billion across the aforementioned property types, but the latter half of the year saw a sharp decline, a trend that continued into the first quarter of 2023 with a 59% year-over-year decrease.

This lending crunch may be exacerbated by yet another interest rate hike from the Federal Reserve, anticipated to occur later this month, by raising its policy rate another 25 basis points to a range of 5.25%-5.50%. This move could further impact the borrowing landscape by nudging lenders to take another step toward inactivity.

As the initial swell of loan maturities rises, CMBS delinquency rates remain historically low, particularly within the industrial sector. Office delinquencies, however, have risen 2.9 percentage points since December 2022 and are on par with 2018 delinquency levels at 4.4%.

The size of the recent increase would suggest that a return to the COVID-19 highs in the mid-6% range is feasible for the office sector over the next several quarters.

Borrowers heading toward near-term loan maturities probably will explore a wide range of lender options before their obligations come due. According to market sources, debt funds and life insurance companies have shown a desire to fill some of the void left by regional banks, which have tightened lending standards and prioritized their depository relationships.

As the scarcity of capital intensifies, lender allocations for 2024 may become depleted in the first half of the year, creating a slow-motion scenario where borrowers compete for fewer chairs as the music fades.