In February, a PIMCO-owned landlord of seven office buildings in California, New York, and New Jersey stopped paying on a mortgage with an adjustable rate because the monthly payments went up because of high interest rates.
Due to low demand for office space, Brookfield, the biggest owner of office space in downtown Los Angeles, decided that month not to refinance loans on two buildings instead of paying them off.
Morgan Stanley says that more than half of the $2.9 trillion in commercial mortgages will be up for refinancing in the next two years. This is a good sign of what is likely to come.
In a recent report, Morgan Stanley’s Chief Investment Officer Lisa Shalett said, “Even if current rates stay the same, new lending rates are likely to be 3.5 to 4.5 percentage points higher than they are for many of CRE’s existing mortgages.”
Even before Silicon Valley Bank and Signature Bank went bankrupt in March, the commercial real estate market was facing a number of problems, such as less demand for office space because more people work from home, higher maintenance costs, and interest rates that were going up.
Experts say that the situation could soon get worse because 80% of commercial real estate loans come from small and medium-sized banks.
Analysts at Morgan Stanley say that commercial property prices could fall as much as 40%, which would be similar to what happened during the financial crisis of 2008.
Shalett says that these kinds of problems can hurt not only the real estate business but also the businesses that are related to it.
Is All Commercial Real Estate in Trouble?
Office buildings, shopping centers, multi-family apartments, hotels, and data centers are all types of commercial real estate.
Mark Grinis, who is in charge of real estate, hospitality, and construction for EY in the Americas, says, “It’s a big pot of assets.” “Our data centers and industrial buildings that power e-commerce are doing quite well if you go there. If you go into the business of renting out multiple units, rents may be going down a little bit, but there’s still not enough housing. The big problem is office space, which is going through a big change.”
Since 2021, there have been 44% more office loans in default and 55% more in special servicing, according to Trepp, a provider of commercial real estate data and insights.
Grinis says, “There is no doubt that storm clouds are getting bigger.”
Private Equity to The Rescue of Office Buildings?
Grinis says that in the short term, poorly structured, capitalized, and financed buildings are likely to either change hands or go into foreclosure.
Grinis says, “You’re going to see some eggs broken as these (mortgages) mature and come due.” “And they either have to find someone who will give them more equity capital or get their lender to be flexible, or it will go back to the bank.”
Expect private capital to step in when the price is right.
“It’s a publicly traded security, and a lot of people look at some of these office stocks and say, “God, these are a pretty good buy,” so private equity will be there at some point when the price is right.
Perspective from A Real Estate Firm
Kip Sowden, the CEO of RREAF Holdings in Dallas, which is a private real estate investment firm with $5 billion in assets under management, says that tighter lending requirements have hurt business.
The company builds multi-family homes, beachfront resorts, large residential communities, extended-stay hotels, and RV parks, and it does business in 14 states.
He said that the company did more than $1.5 billion in deals in 2022, up from $1.3 billion in 2021.
“And we think that in 2023, those numbers will probably be cut in half because interest rates will be higher and the number of deals that banks will want to fund will go down.”
Sowden borrows money from regional banks, and he says that the requirements for underwriting have become very strict.
“A lot more money is needed to do business now than in the past,” he said.
Office-To-Residential Conversions Are Top of Mind
Since the pandemic, when office buildings were left empty, people have been talking a lot about turning them into homes.
Experts say that state and local officials can help developers who are stuck with properties that aren’t being used while also solving the problem of affordable housing in cities by making the zoning changes needed for these conversions happen faster.
Grinis says, “Cities like New York and San Francisco are jewels of the urban landscape, and no one benefits when these cities are in trouble.” “Therefore, there is a call to action for governments, private capital, and maybe, in some ways, regulators and lawmakers to make sure that cities stay lively.”