In February, a PIMCO-owned office owner defaulted on an adjustable-rate mortgage on seven office properties in California, New York and New Jersey when monthly payments rose due to high interest rates.
Brookfield, the largest office owner in downtown Los Angeles, chose that month to default on loans on two buildings rather than refinance debt due to weak demand for office space.
They are an indicator of what is likely to happen, as more than half of the $2.9 trillion in commercial mortgages will be refinanced over the next two years, according to Morgan Stanley.
“Even if current rates stay where they are, new lending rates will likely be 3.5 to 4.5 percentage points higher than they are for many existing CRE mortgages,” wrote Lisa Shalett, Chief Investment Officer of Morgan Stanley, in a recent report.
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Even before the collapse of Silicon Valley Bank and Signature Bank in March, the commercial real estate market faced a host of challenges, including declining demand for office space driven by remote working, rising maintenance costs and rising rental rates. ‘interest.
With small and medium banks representing 80% commercial real estate credit, the situation could soon get worse, experts say.
Commercial real estate prices could fall by up to 40% “rivaling the decline of the 2008 financial crisis”, analysts at Morgan Stanley predict.
“These kinds of challenges can harm not only the real estate industry, but all of the business communities connected to it,” says Shalett.
Is all commercial real estate in trouble?
Commercial real estate includes office buildings, shopping malls, multi-family apartments, hotels and data centers.
“It’s a broad spectrum of assets,” says Mark Grinis, head of real estate, hospitality and construction at EY Americas. “If you go to our data centers or our industrial buildings that power e-commerce, they do pretty well. If you’re going into the multi-family business, rents might go down a bit, but there’s still a housing shortage. The elephant in the room is the office space, which is undergoing transformative change. »
As for office loans, since 2021, 44% more in volume were overdue and 55% more were on special duty, according to Trepp, a provider of commercial real estate data and information.
“The storm clouds are forming,” says Grinis.
Private equity to the rescue of office buildings?
In the short term, buildings that are poorly structured, capitalized and financed will likely undergo some sort of change of ownership or be subject to foreclosure, says Grinis.
“You’re going to see broken eggs as these things (mortgages) mature and mature,” Grinis says. “And they either have to find someone who will give them additional equity, or they have to make their lender flexible, or it will come back to the bank.”
When the price is right, expect private capital to step in.
“It’s a publicly traded security and a lot of people are looking at some of these office stocks and saying, ‘God, this is a really good buy’, so the private equity will be there, at some point, when the price will be right.”
Point of view of a real estate agency
Kip Sowden, CEO of Dallas-based RREAF Holdings, a private real estate investment firm with $5 billion in assets under management, says he’s seen business shrink due to tighter lending requirements.
The company, which operates in 14 states, develops multi-family homes, resorts, large residential communities, extended-stay hotels, and is in the process of developing RV parks.
In 2022, the company surpassed $1.5 billion in transaction volume, up from $1.3 billion in 2021, he said.
“And in 2023, we believe those numbers will likely be halved due to rising interest rates and just a contraction in the number of transactions that financial institutions will seek to fund.”
Sowden, which borrows from regional banks, says underwriting requirements have become very strict.
“Much more equity is needed to transact than before,” he said.
Office-to-residence conversions are a priority
Office-to-housing conversions have been a hot topic of discussion since the pandemic emptied office buildings.
State and local authorities can help developers struggling with languishing properties while addressing affordable housing challenges in cities by speeding up the zoning changes required for such conversions, experts say.
“Cities like New York and San Francisco are gems of the cityscape and no one benefits when these urban centers suffer,” says Grinis. “And so, there’s a call to action when it comes to governments, private capital, and perhaps to some degree, regulators and legislators to make sure the vibrancy of cities continues.”
Swapna Venugopal Ramaswamy is housing and economics correspondent for USA TODAY. You can follow her on Twitter @SwapnaVenugopal and sign up for our Daily Money newsletter here.