Downward angle icon Downward angle icon. Reuters Capital Economics warned that commercial real estate will finally go bust in 2024 as many property owners choose to “extend debt and pretend everything is fine,” it said. But $2.2 trillion in CRE debt comes due by 2027, which could set off a wave of distress.
According to Capital Economics, the brewing crisis in commercial real estate may finally reach a breaking point this year.
The research firm pointed to the pessimism that has enveloped the commercial real estate sector over the past year, with critics warning that tighter credit conditions and falling debt repayment deadlines from property owners could lead to a collapse in the property market.
The company said about $541 billion in commercial real estate debt officially comes due in 2023, but the impact was minor because many loans have been extended.
That's a sign that many building owners are considering “extending and showing off,” but with $2.2 trillion in commercial real estate debt coming due through 2027, this strategy can't last forever, according to Kiran Raichura, a real estate economist at Capital Economics.
Rising interest rates and tough credit conditions have led lenders to shy away from making riskier commercial real estate loans or to only do so at higher borrowing costs.
Capital Economics estimated that some borrowers could see interest rates double after refinancing maturing loans, leading to a wave of defaults and delinquencies.
“We expect intensifying signs of dissolutions this year as loan extensions expire. Many borrowers will be forced to either inject fresh capital, return assets to lenders or sell in a soft market. Assets returned to lenders will also eventually come onto the market, leading to pricing clarity and significant valuation write-downs,” Raichura said in a note on Monday.
Some commentators have dismissed the possibility of that outcome, pointing to expectations that the Fed will cut interest rates later this year.Meanwhile, real estate investors such as Brookfield are raising capital to buy up cheap commercial property as it hits the market.
But the Fed's rate cuts are likely to disappoint investors, and companies aren't able to raise enough capital to buy the total amount of commercial real estate debt approaching maturity, Raichura said. In December, private equity firms had allocated $250 billion to real estate, just 11% of the sector's total maturing debt.
“Taking all this together, we expect distress to worsen this year as borrowers and lenders cannot continue to put off the problems,” Raichura said.
Commercial real estate defaults and late payments are already on the rise, and property values are starting to fall: The sector is currently in the midst of its biggest price decline in half a century, with values falling about 11% last year, according to the International Monetary Fund.
Laichura expects the woes to get worse this year, with prices expected to fall another 10% in 2024, bringing the peak-to-trough decline to 20%.
Some commentators have warned of an even worse collapse for commercial real estate, with one NBER paper estimating total losses for the CRE sector could reach $160 billion.
Veteran investor Kyle Bass has warned that problems in commercial real estate and a sudden drop in demand for office buildings could cost the U.S. $250 billion in losses from a collapse in office building prices alone.