Office Loan Defaults At Highest Point In More Than A Decade

High interest rates and low demand have led to the number of U.S. office buildings threatened by default reaching its highest point since the fourth quarter of 2012, The Wall Street Journal reported Tuesday.

Around $38 billion worth of office buildings are currently facing defaults, foreclosures or another form of financial distress, according to data from finance firm MSCI acquired by the WSJ. The defaults are part of a larger commercial real estate crisis, as high interest rates set by the Federal Reserve to combat elevated inflation and a slump in demand due to a rise in work-from-home policies have left office owners with huge debts and struggling to find tenants.

The payoff rate for commercial mortgage-backed securities (CMBS) in 2023 was at its lowest point since data began being collected in 2007, with only 35% of office owners paying back their loans at the end of their term, according to the WSJ. In 2021, more than 90% of office owners with a CMBS did so.

“The problem you have in office is, in many instances, there is no cash flow at all,” Bill Demchak, PNC Chief Executive, said on an earnings call, according to the WSJ. “It is really a unique animal at the moment.”

Only interest is typically paid for CMBS during the term of the loan, with the full amount being paid at maturity, or it has to be refinanced with current interest rates. Refinancing could pose an issue for commercial real estate owners due to a jump in interest rates as a result of the Federal Reserve setting its federal funds rate in a range of 5.25% and 5.50%, the highest level in 23 years.

The Fed set its rate to its current level in an effort to decelerate inflation, which peaked at 9% in June 2022 and is currently at 3.5% as of March, far higher than the Fed’s 2% target.

Not a good sign when small banks balance sheets are already 30% CRE and that share has been slowly growing over the last month after only briefly dropping: pic.twitter.com/zilY3eD5Kr

— E.J. Antoni, Ph.D. (@RealEJAntoni) April 27, 2024

Around $18 billion in office loans that were converted to CMBS in the past are set to come to term in the next 12 months, twice as many that matured in 2023, according to the WSJ. Office vacancy rates are also up to a record 13.8%, as opposed to 9.4% at the end of 2019.

Office owners are resorting to bolstering the amenities offered in their buildings to lure wary tenants who don’t necessarily need office space, driving up costs to obtain renters, according to the WSJ.

Defaults in commercial real estate pose a particularly big issue for small- and medium-sized banks that hold an outsized portion of CMBS. The mid-sized New York Community Bancorp experienced a massive drop in its stock earlier this year after posting a $252 million loss in the fourth quarter of 2023, largely due to commercial real estate loans, leading a group of investors, including former Treasury Secretary Steven Mnuchin, to bail out the bank.

AUTHOR

WILL KESSLER

Contributor

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