Archives for 2024

Commercial real estate loan delinquencies among U.S. banks continue to pile up as the nation sees fallout from a post-pandemic office market.

The delinquency ratio for CRE loans across banks rose 16 basis points in the second quarter, to 1.4%, according to data from S&P Global Market Intelligence. It’s the seventh consecutive quarterly increase for that metric. To deal with rising vacancy and plummeting values of office buildings — leading to the uptick in delinquent or distressed loans — more banks with large office portfolios have been lifting loss reserves incrementally.

Also because of the stress in commercial real estate right now, banks continue to pull back on new issuance to the sector. Year-over-year CRE loan growth across U.S. banks slowed to 2.2% in the second quarter, compared to 2.9% the prior quarter and down substantially from a recent peak of 12.1% in the third quarter of 2022.

Many lenders, banks included, have thus far largely opted to issue short-term extensions on maturing loans backing commercial real estate properties, or are adjusting loan terms at refinancing.

“The catalyst that would really force the issue here is the maturity wall, when these loans mature,” said Nathan Stovall, director of financial institutions research at S&P Global Market Intelligence. He added S&P is estimating 2027 to be the peak year for CRE loan maturities, with nearly $1.26 trillion expected to come due that year. An estimated $950 billion in commercial real estate mortgages is expected to mature this year.

Although federal regulators are concerned about banks with elevated exposure to commercial real estate, so far they’re largely still allowing those institutions to extend loans and give borrowers more time, Stovall said.

It’s likely there will be more merger-and-acquisition activity among banks with heightened exposure to commercial real estate, with one example being Bank of America Corp. (NYSE: BAC) agreeing in May to purchase a portfolio of Washington Federal Bank’s (Nasdaq: WAFD) multifamily properties for $2.9 billion.

M&A deals overall have been slow, but it’s likely activity will start picking up in 2025 depending on the economy’s trajectory, Stovall said.

At the same time, the number of banks exceeding a threshold regulators set in 2006 for CRE loan exposure is dwindling. Regulators set that threshold to include banks in which CRE loans represent more than 300% of risk-based capital and 36-month CRE loan growth of 50% or more, or construction and development loans that are at least 100% of a bank’s risk-based capital.

The number of banks exceeding that regulatory guidance in Q2 fell for the fifth consecutive quarter, to 482. The number of banks that exceeded the criteria hit a recent peak in Q1 2023, at 577. Although unrelated to U.S. commercial real estate fallout, that happened to be the same quarter as the failures of Silicon Valley Bank and Signature Bank.

“After that happens, it’s all hands on deck in the regulatory community,” Stovall said, adding attention has since turned to banks with significant office-market exposure. “We have changes in the way people work. You’ve seen net outmigration from certain cities. It’s location location location when it comes to real estate. I think, ultimately, [regulators] have the tools in the toolbox, but they’re pushing harder on those tools.”

Amid recent M&A activity, some banks have upped their exposure to commercial real estate, putting them on the radar of regulators. Provident Financial Services Inc., for example, newly exceeded CRE loan-exposure guidance in the second quarter after it purchased Lakeland Bancorp Inc. Regulators approved the deal with a number of conditions, including a $200 million capital raise.

“That gives you an idea that they’re getting more aggressive,” Stovall continued.

Among the 20 banks with the largest CRE portfolios, such loans fell by a median 2.1% year over year as of Q2, with a dozen of them posting declines.

Although more banks are on regulators’ radar because of the fallout in commercial real estate, there are still a number of factors that will help insulate the financial system from a more crippling effect, Stovall said. For example, underwriting standards heading into the pandemic were much stricter than they were ahead of the Global Financial Crisis, and more equity was required in deals. And even though fallout in commercial real estate is widely expected to be a long-term storyline, delinquencies today are still a fraction of what they were during the 2008 downturn, Stovall said.

“Those are all good things,” he said. “There’s this huge private-equity market chasing after real estate assets. It’s going to be put to work. There might be alternatives [to banks]. It doesn’t erase any problems here but it puts a floor on it from where it would be otherwise.”

Interest-rate outlook

All eyes are on the Federal Reserve, which is widely expected to issue its first interest-rate cut later this month amid a cooling labor market and reduced inflation.

While rate cuts are seen as a way to unlock more liquidity in the market, including commercial real estate, one or two rate cuts aren’t likely to make a huge difference ultimately in the challenges facing the sector.

The average interest rate on CRE loans that originated this year is 6.2%, compared to an average 4.3% on mortgages about to mature. That’s nearly a 200 basis point difference, a gap that won’t be covered by a couple of rate cuts, Stovall said.

“This thing takes longer than I think a lot of people thought six or nine months ago,” he said. “Rate cuts help, but I don’t think it honestly changes the story. [And] if rates fall 200 or 300 basis points in the short term, the Fed is seeing something really bad [in the economy].”

Source: “Commercial real estate loan delinquencies see uptick among banks”

Double-digit cap rates have become pervasive for Class B and C properties, according to an analysis by CBRE. This comes after the firm reported earlier this year that Class C office yields were frequently exceeding junk bond levels.

Pension funds are limited in the amount they can invest in below-investment-grade fixed-income assets. Junk bonds have high yields but a greater risk of default.

Earlier this year, CBRE’s Cap Rate Survey (CRS) showed double-digit yields for Class C offices, particularly in central business districts including San Francisco, Minneapolis, Houston and Philadelphia. This signals highly challenged office properties as cap rates near 15% suggest the assets have become the equivalent of junk bonds. However, high yields can attract capital from hedge funds and other risk-tolerant investors, which can translate into attractive IRRs, said CBRE.

Going into the second half of 2024, high yields have climbed for marginal buildings despite thin office sales volume, according to CBRE’s CRS. The percentage of office properties that are estimated to have cap rates 20% or higher has grown exponentially over the past year and a half, CBRE said.

“We can take some solace in the fact that the growth of above-10% cap rates has slowed to 18% in H1 2024 from 56% in H1 2023,” CBRE said. “Further, most CRS participants expect that office yields will remain flat or slightly decline in coming quarters. This corresponds with other evidence that office market fundamentals are beginning to stabilize.”

Overall, the average survey cap rate held steady during the first half, and different property types reacted differently to changing fundamentals and capital markets drivers, said CBRE. For example, industrial cap rates fell on average while office yields continued to climb. Survey respondents largely indicated they believe cap rates have plateaued. The share of respondents expecting further devaluations was highest within the office sector, reflecting the uncertainty around market fundamentals.

The share of respondents who believe cap rates will increase during the next six months has fallen compared with CBRE’s previous two CRS publications. This improved sentiment is likely driven by more accommodative signals from the Fed and the decline in bond yields from their October 2023 peak, the firm said.

Source: “Double-Digit Office Cap Rates Continue to Climb”

The gap between homeownership and rental costs has continued to widen during the second quarter, according to Newmark’s most recent multifamily capital markets report. The gap increased 26.7% year-over-year to $1,114.

Meanwhile, MBA’s Mortgage Application Index, a housing and mortgage market indicator, has decreased 48.4% since March 2022 when the Fed initially increased rates. Applications are at the second lowest level in nearly a quarter century as the 30-year fixed mortgage rate hit 6.86% during the quarter. Borrowing costs for homebuyers are 43% above the five-year average, said Newmark.

Benefiting from decreased home affordability, multifamily demand increased 102% during the second quarter to 161,707 units, according to the report. Rolling four-quarter demand accelerated to 389,629 units, which has improved for five consecutive quarters, said Newmark. Demand was particularly strong in the Sun Belt – particularly Austin, Raleigh/Durham, and Nashville – where demand was 64.4% greater on average than the long-term average from 2014 to 2023. ​

Just over 157,000 units were delivered during the second quarter, topping the previous record units delivered of 126,591 during the first quarter of this year. New deliveries are expected to continue to accelerate in the third and fourth quarters of 2024, before slowing down in the first quarter of 2025, Newmark said.

Despite high levels of new supply, rolling four-quarter starts and permits have declined from their peak in 2022, which should lead to normalized levels of deliveries in 2025 and 2026. Multifamily units under construction declined to 880,000 in the second quarter, down 11.4% year-over-year. Units under construction peaked at 993,000 units during the second quarter of 2023, according to Newmark.

Quarterly rent growth rose to 1.1% in the second quarter of 2024, while year-over-year growth remained nearly flat at 0.2% for the third quarter consecutively. But year-over-year rent growth is projected to increase throughout the second half of 2024 and 2025 as new supply fears wane, said Newmark.

During the next two years, $669 billion in multifamily loans are scheduled to mature, primarily held by GSEs and banks. This is despite originations declining 32% and 22% year-over-year respectively. Commercial mortgage-backed securities have been a bright spot, with 167% year-over-year growth during the first quarter of 2024, said Newmark.

Sales volume rose to $38.8 billion in the second quarter of 2024, representing a 20.4% year-over-year increase in volume as a flurry of portfolio and entity-level transactions closed throughout the quarter. This also signifies the first sequential positive year-over-year change in volumes since the second quarter of 2022.​

Source: “Multifamily Demand Rose 102% in Q2”

Much of the discussion about commercial real estate through and after the formal pandemic has been a triptych. The asset classes include office, multifamily, and industrial. The first one quickly tumbled. The second and third were investment darlings. Retail was assumed to be on a crash-and-burn trajectory with extended and sustained pandemic closings.

Now? Retail is looking pretty good, according to an analysis by the Brookings Institution. A start to the story is retail having done surprisingly well during the pandemic while office did poorly. And multifamily — assumed to be an impossibly steady investment because people need to live somewhere, and houses are expensive — had comparable losses.

Using data from CoStar, Brookings noted that while CRE values usually move roughly in step, from 2019 to 2024, that has not held true. Office fell from $3.17 trillion to $2.43 trillion, a drop of $740 billion, or 23.3%. Multifamily went from $4.91 trillion up to an exaggerated height valuation beyond any other class of about $6.1 trillion. Then the asset class slid to $4.61 trillion. The end-to-end drop was $300 billion, or about 6.1%. But the drop from the high point to current value was almost $1.5 trillion, or roughly a 24.4% drop, a bigger dip than office.

Industrial netted an increase from $2.24 trillion to $2.91 trillion, an increase of 29.9%, the definite highflier. Retail had only a slight increase of $3.01 trillion to $3.03 trillion — up about 0.7%. But as Brookings separately pointed out. retail has been the most stable CRE asset class during the pandemic. In 2019, demand was $11.4 billion, with inventory at $11.92 billion. In 2024, demand is $11.61 billion; inventory is $12.11 billion. What makes the stability more remarkable is an interesting dynamic that becomes clear in the important net-lease segment.

After the subprime collapse, many investors became interested in multifamily. They bought, saw values go up, and then became exchange buyers, getting into retail and pushing up prices because they could afford to spend more to get what they wanted because of the tax advantages. “There were so many exchange buyers that they quite substantially moved the market,” Chris Lomuto, an associate vice president in Northmarq’s San Francisco region, told GlobeSt.com. Rising interest rates did away with the advantages and that money tap was turned off. There were far fewer exchange buyers willing to pay more, moderating prices and transaction sizes. That might also have become a stabilizing force.

Brookings looked at total returns — an estimate of the nominal rate of return on unleveraged property investments — by property type. The 2019-to-2024 comparisons of percentage return were industrial, 10.97% to 1.59%; multifamily, 7.26% to -6.54%; office, 4.56% to -5.02%; and retail, 5.3% to 3.56%. And at 4.08%, retail’s national vacancy rate was the lowest of the four asset types and at a five-year low, although the numbers can vary widely by locality.

The stability and resilience seem to have put retail in a good position for future investment.

Source: “The Often Overlooked Bright Future of Retail CRE”