The office sector has faced significant challenges since the pandemic, with U.S. commercial mortgage-based securities, or CMBS, having seen default rates jump by nearly a factor of four since the pandemic.
But there’s also been a fundamental shift in how the submarkets of central business district and suburban offices act — and they make up 90% of the overall category — as a new report from Trepp CRE Research indicates. The shift is in those same CMBS default rates.
In the past, from at least 2016, peaking in mid-2017, and then on to December 2019, there was always better performance in CBD office than suburban. Looking at that peak for a moment, a category of all office soared to about an 8% default rates. The highest CBD office went was a brush with 5%. Suburban offices topped 18%.
Starting in late 2019, the differences between suburban and CBD shrank, with the former being a little above 3% and the latter below 2%. As of August 2023, CBD office was up to 6% and suburban, about 5% — a complete inversion.
It might be a matter of volume. “Looking at loan originations for the office sector as a whole, the volume has diminished from last year, with suburban loans hit particularly hard,” the report says. “Both urban and suburban loan originations decreased from 2022, with originations for urban falling to $1.6 billion from $3.8 billion, and the original balance of suburban loans falling to just $182 million in 2023 from $1.7 billion in 2022. The suburban drop is especially notable considering that the average loan size is less than one-third the size of urban areas.”
The data immediately raises a question of whether there has been a quality self-selection as lenders have sharply raised their standards. It could be that the big reduction in suburban office loans meant only the ones with stronger financials were funded, cutting what had been greater loss levels through more stringent underwriting.
Trepp addresses this in part. Urban offices generally had had conservative debt yields and loan-to-value ratios. LTV was roughly 10% lower in 2023 compared to a trailing five-year average. Issuers have required about 15% debt yield in 2023 rather than the older norm of 10% to 11%.
“These numbers highlight the difficulty of potentially refinancing as these loans mature,” they wrote, with more than $90 billion in loans to mature in the current quarter. Office composes 22% of the total, the biggest percentage.