Welcome to First American Title NCS's CRE News Digest, where we cover the biggest news in commercial real estate. As a long-established brand that has been in CRE for over 120 years, First American knows the market and the forces affecting our clients' businesses.
The big picture: transactions and maturing debt
Impending debt maturities in the commercial real estate industry remain a top priority among industry experts when exploring the state of the market. In a recent analysis, First American Senior CRE Economist Xander Snyder explored the relationship between the current decline in CRE deals and upcoming debt maturities for the industry to better understand how and when deal volume will recover.
The low interest rate environment following the global pandemic saw CRE deal volume reach record highs, making a decline seem inevitable. However, the decline in deal volume in the first quarter of 2024 compared to pre-pandemic figures was significant, dropping by approximately 57%. As the industry waits for a recovery, Snyder and other experts believe that the volume of CRE mortgages maturing between this year and 2025 will narrow the gap in outstanding price expectations between buyers and sellers, causing CRE deal volume to rise again.
According to the Mortgage Bankers Association, an estimated $930 billion in CRE mortgages will come due in 2024, but with little to no sign of interest rates decreasing in the near future, many owners will be forced to refinance at significantly higher interest rates or sell their properties at a reduced price. Many buyers are looking to purchase properties that are being forced to sell due to maturing loans, which has increased overall CRE transaction volume. Additionally, how this maturing debt will affect banks is a frequent topic of discussion within the industry. However, Snyder explains that the impact of these maturing loans goes beyond banks, because more than 60% of outstanding CRE loans are held by non-bank entities. These entities have different risk tolerances and flexibility, and while some properties with maturing debt will be easier to refinance, others will likely face distress and foreclosure.
The pain of CRE pricing corrections and debt maturities is already being felt across the industry, but there's still a lot to be done, and it won't happen soon. Snyder predicts that due to the slow pace of bad loan management and restructuring, it may not be until the first half of 2025 that the full impact of 2024 debt maturities will be felt.
State of the Industry: Office
The office sector is still struggling to adapt to a post-pandemic world with reduced tenant demand. According to Moody's, the office sector will end the first quarter of 2024 with a vacancy rate of 19.8%, surpassing the previous record highs of 1986 and 1991. However, office rents have not consistently fallen, and in some regions have even increased. In the CRE industry, rents serve as an indicator of a property's value to lenders and other key players. Lowering rents significantly could reduce cash flow and lead to loan defaults. However, as remote and hybrid work becomes more established, experts expect rents to eventually fall due to debt maturities caused by high vacancy rates. Sales and foreclosures due to rent maturities will cause rental prices to adjust to reflect market conditions.
The office vacancies are not only affecting the office sector, but the entire CRE industry. According to a BBC report, small businesses in office districts across the country are struggling with the “new normal” of empty offices. Jimmy Yabrody, a local restaurant owner in New York City, explained that his business relies on office workers stopping by for a meal on a normal workday, and he's already seen a 70% drop in sales since 2020. “If they don't come to work, places like ours can't survive,” he said. While many companies have implemented office reopening orders and are slowly filling their office spaces and bringing back employees, it won't be enough to sustain retail businesses in the long term in office districts where rents are already high.
Innovation: SEC Emissions Reporting Standard Updates
In March, the U.S. Securities and Exchange Commission (SEC) approved a rule requiring large companies to report some of their carbon emissions, but exempts Scope 3 emissions reporting from the requirement. The rule also requires climate risk disclosures to be included in all filings with the SEC. The decision will require large landlords and CRE operators to report Scope 1 and Scope 2 emissions, which include emissions released from direct and indirect activities, such as burning fuel and using electricity to heat buildings.
The omission of Scope 3 emissions reporting is a relief for the CRE industry as these emissions are difficult to define. Scope 3 emissions include indirect emissions related to a company's carbon footprint, which for CRE companies is the carbon that comes from the construction and demolition of buildings. While the exclusion of Scope 3 emissions is controversial, avoiding emissions from tenant operations simplifies the reporting process for CRE companies.
Overall, the SEC’s ruling highlights the growing importance of environmental and climate-related disclosures to the CRE industry, particularly for landlords and investors.