In this episode of “The Inside Look,” Senior Commercial Real Estate Economist Xander Snyder discusses what to expect from the CRE market as $1 trillion in outstanding loans mature over the next two years.
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Transcript:
Hello, I'm Zander Snyder and this is First American's Inside Look.
With over $1 trillion in commercial real estate loans coming due over the next two years, many are rightly wondering what borrowers will do when their loans come due and they need to refinance at higher interest rates. In other words, when will the so-called “disaster” happen for the commercial real estate sector? The problem is, all of this hardship probably won’t happen in one shocking moment.
Losses from distressed sales happen bit by bit, not all at once. We've already seen some such distressed cases, especially in office space. One loan that made headlines was a commercial mortgage-backed security (CMBS) loan for a large office building in New York City. The property was purchased in 2014 for $605 million, about half of which was funded by the CMBS loan and the rest by the buyer's own equity.
In 2022, the owner of this building handed the keys back to the special servicing company, meaning that they suffered a complete loss on their equity position. At this point, the special servicing company's job is to find the best solution for the investors in the debt portion of the capital structure. As an important background, CMBS are routinely split into different tranches. The junior tranches earn higher interest income but are the first to suffer losses if they are unable to collect the full amount of the loan.
Then in April of this year, the loans were sold at an effective 62% discount, including transaction-related fees, resulting in a complete loss for all bondholders except for the highest-rated tranche, the triple-A tranche, whose investors lost roughly a quarter of their investment. In fact, the loss of the triple-A tranche is why this bond sale attracted so much attention, as it was the first time a triple-A tranche of CMBS had suffered a loss since the aftermath of the 2008-2009 global financial crisis. In total, the bond sale recovered less than 20% of the funds used to purchase the buildings in 2014.
Moreover, in 2021, the largest tenant, accounting for roughly 70% of the office space, moved out and did not renew its lease before the previous owner took a full loss. While the office sector's problems are well known now, not all buildings are facing such severe occupancy declines. Still, any office defaults that do occur will come one by one, hitting specific properties individually, rather than delivering a knockout punch to the entire sector all at once.
My colleague Odeta Kushi and I will be discussing the current state of the commercial real estate economy in a webinar on July 17th. If you would like to register, please visit our social media pages @XanderSnyderX (me) and @odetakushi (Odeta). We will share the registration link. Additionally, we will be doing several speaking engagements in the Midwest in September in Cleveland, Columbus and Indianapolis. If you are interested in attending any of these, please reach out to your local First American representative.