New warning signs are flashing for commercial real estate. Little-known investment vehicles used to finance risky projects are facing unprecedented stress as borrowers struggle to repay loans tied to commercial real estate operations. Known as commercial mortgage-backed obligations (CRE CLOs), the products bundle together debt typically deemed too speculative for traditional mortgage-backed securities. Over the past seven months, the share of non-performing assets held by these niche products has surged fourfold, to more than 7.4% by one measure. In the hardest-hit areas, delinquency rates are reaching double digits. That has left major players in the $80 billion market scrambling to restructure loans and short sellers stepping up their attacks on public issuers.
Of course, this pain is part of a broader post-pandemic turmoil in the $20 trillion U.S. commercial real estate market, which nearly bankrupted New York Community Bancorp and drew warnings from Treasury Secretary Janet Yellen and Federal Reserve Chairman Jerome Powell. But industry observers say some products are riskier than CRE CLOs. “The CRE CLO market is the first to be affected in terms of defaults in the CRE debt market,” said Mark Neely, director of alternative investments at asset manager Gentrust. “Because loans within CRE CLOs tend to be for transitional properties, borrowers expect to resell before the loan matures. But today, many borrowers are unable to sell their properties for anything close to their purchase price.”