There have been some signs over the past few years that commercial real estate is headed for a major downturn. Office vacancy rates hit a 30-year high of roughly 18% in 2023. Large and small companies alike have responded to the new norm of remote and hybrid work by drastically reducing space, with some even terminating leases early.
But one of the most dire figures that shows the doom headed for commercial real estate is the total amount of mortgages maturing in 2024. The Mortgage Bankers Association projects that of the $4.7 trillion in outstanding commercial mortgages held by lenders and investors, $929 billion will mature this year, according to its Commercial Real Estate Loan Maturity Volume Study report released Monday.
“Volatility and uncertainty around interest rates, uncertainty about property values and questions about some real estate fundamentals are restraining sales and financing activity,” Jamie Woodwell, head of commercial real estate research at MBA, said in a statement.
Kevin Fagan, head of CRE economic analysis at Moody's Analytics, told Fortune that the problem is especially acute in office buildings, saying “the current weakness in CRE property performance is highly concentrated.” “This could spell trouble for some tenants who may have trouble refinancing in a high-interest rate environment, further slowing demand for commercial real estate,” Fagan said.
Office space surplus
If demand for office space declines, the glut will only get worse: Last year, Cushman & Wakefield predicted that unused office space could reach 1 billion square feet by the start of the new decade, and the situation is likely to worsen as more loans come due and leases expire.
Lower demand could lead to an increased oversupply of office space, which could lead to a significant drop in prices, putting lenders and landlords in a bind. Indeed, a Morgan Stanley report suggests that office prices could face a 30% drop, or “price correction,” as a result of lower demand.
“Office as a property type faces long-term challenges,” the bank said in a Sunday note. “Demand for office property is unlikely to return to pre-pandemic levels. This means that property valuations, lease agreements and financing structures will need to adapt to the realities of post-pandemic office operations. This shift has begun and is likely to continue.”
Citing data points from Real Capital Analytics, the bank added that office prices have already fallen 20% from their peak.In mid-December, Capital Economics released its 2024 outlook, predicting that commercial real estate asset values will fall a further 10% in 2024, after falling 11% in 2023.
The story continues
Commercial property values and low occupancy rates tell the story of the dire situation the market faces, but they're not the whole story, Michael Immerman, an assistant professor at the Paul Merage School of Management at the University of California, Irvine, told Fortune.
“This is a question of existing financing,” he said, explaining that many commercial real estate developers took out large loans after the 2009 global financial crisis when interest rates were low. Many of those loans are now coming due.
“Interest rates have increased significantly over the past 18 months, so the owners of these properties – real estate developers and investors – will be forced to refinance at much higher rates,” he said. “That, combined with low occupancy rates, will make it impossible to repay these loans, and we're going to see a lot of commercial real estate delinquencies over the next few years.”
This is already happening: Delinquency rates for mortgage-backed commercial real estate rose 6.5% in the fourth quarter of 2023, according to a January MBA report.
“Continued challenges in the commercial real estate market have led to rising delinquency rates for CRE-secured loans in the final three months of 2023,” Woodwell said in a statement. “While long-term interest rates have declined from last year's highs, which should provide some relief for some loans, many properties and loans still face rising interest rates, uncertainty regarding property values and, for some properties, changing fundamentals.”
This story originally appeared on Fortune.com.