Recent data from Moody’s Analytics reveals that securing new financing for old office loans, which were bundled into bond deals by Wall Street several years ago, has become increasingly difficult. This presents a concerning trend for the commercial property market. During September, only 11.1% of office loans, totaling nearly $755 million, were repaid upon maturity by landlords who had obtained funding through the commercial mortgage-backed securities market.
Typically, landlords rely on refinancing their debt rather than fully repaying it. This allows building owners to continue earning a return while staying current on their obligations. However, the inability to refinance often leads to a rise in defaults. This, in turn, triggers fire sales in cities such as San Francisco and other major metropolitan areas, potentially resulting in more property owners surrendering buildings to their lenders instead of struggling to maintain them.
While September did witness a slightly higher payoff rate compared to July and August, according to Matt Reidy, the director of commercial real estate economics at Moody’s Analytics, loan repayments over the past few months have been considerably low. Landlords are increasingly relying on loan extensions or modifications to manage their debt obligations as higher interest rates and declining property values decrease their chances of refinancing. Savills Research reports that office availability rates in the United States have spiked to 24.4%, representing an increase of over 1,000 basis points since before the pandemic.
Reidy emphasizes that the current payoff rates highlight the immense difficulties faced by office loans in meeting their obligations. While loan extensions provide temporary relief, they are not a long-term solution. In September, 89% of loans reached maturity default, as illustrated by the dark-blue line on the graph. Consequently, Goldman Sachs announced during its third-quarter earnings call that it had marked down or impaired its office real estate investments by 50% this year.
The mounting challenges in securing new financing for old office loans suggest a turbulent future for the commercial property market. Landlords and building owners must navigate these obstacles while exploring alternative solutions to mitigate potential defaults and maintain stability in their portfolios.
Federal Reserve Officials Warn Higher Interest Rates Needed
Federal Reserve officials have recently been cautioning that the central bank’s policy interest rate may need to remain higher for a longer period. This measure is aimed at ensuring that inflation continues to decrease and reaches its target annual rate of 2%. In July, the Fed raised the short-term rate to its highest level in 22 years, ranging from 5.25% to 5.5%. It is expected that this level will be maintained after the upcoming policy meeting. However, the possibility of further rate hikes remains open.
Impact on Wall Street Bond Deals and Commercial Real Estate Market
Historically, financing from Wall Street bond deals has played a smaller but significant role in funding the US commercial real estate market, compared to funding from banks. As the Fed aggressively increased interest rates in an effort to combat inflation, fallout from these measures has affected banks.
Former FDIC chair Sheila Bair conveyed a reassuring message, stating “Banks fail. It’s OK.”
With rates expected to remain high well into 2024, more landlords could face challenges in securing financing, especially as remote work continues to adversely impact office properties.
Office Loan Modifications and Defaults
When looking at the entire year, Moody’s Analytics found that thus far, 34.7% of maturing office loans from bond deals have undergone modifications or extensions. Additionally, 34.1% of these loans have defaulted upon reaching maturity, while 31.2% have been fully paid off.
Dampened Outlook and Weak Borrower Demand
The recent autumn surge in the 10-year Treasury yield, rising to nearly 5%, has further dampened the outlook for the commercial real estate market. This increase in yield serves as a benchmark for new property loans and provides insight into overall financing conditions for the US economy.
In a weekly client note, Deutsche Bank analysts highlighted the “very weak” demand from borrowers for 10-year commercial property loans in Wall Street’s bond market. These loans now come with interest rates ranging from 7.5% to 8%. The analysts also estimated that commercial real estate transaction volume has plummeted to levels last seen in 2009, describing the situation as “severely depressed.”
Stock Market Performance
FactSet data reveals that on Thursday, stock market performance was negative across the board. The Dow Jones Industrial Average (DJIA) experienced a 0.7% decline, the S&P 500 index (SPX) was down by 1.3%, and the Nasdaq Composite Index (COMP) fell by 2.1%.