In February, a PIMCO-owned office owner defaulted on an adjustable-rate mortgage on seven office buildings in California, New York and New Jersey when monthly payments increased due to high interest rates.
Brookfield, the largest office owner in downtown Los Angeles, that month decided to default on loans on two buildings rather than refinance debt due to weak demand for office space.
They are an indicator of things likely to come, as more than half of the $2.9 trillion in commercial mortgages will be refinanced in the next few years, according to Morgan Stanley.
“Even if current rates stay where they are, new loan rates are likely to be 3.5 to 4.5 percentage points higher than many of CRE’s existing mortgages,” wrote Lisa Shalett, director of Morgan Stanley investments, in a recent report.
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Even before the collapse of Silicon Valley Bank and Signature Bank in March, the commercial real estate market was facing a number of challenges, including declining demand for office space prompting remote work, higher maintenance costs and fees. of interest on the rise.
Since small and medium banks account for 80% of commercial real estate loans, the situation it could soon get worse, experts say.
Commercial property prices could fall as much as 40% “the same as the drop during the 2008 financial crisis,” Morgan Stanley analysts predicted.
“These types of challenges can harm not only the real estate industry, but entire business communities related to it,” Shalett says.
Is all commercial real estate in trouble?
Commercial real estate includes office buildings, shopping malls, multi-family apartments, hotels, and data centers.
“It’s a wide range of assets,” says Mark Grinis, leader of Real Estate, Hospitality and Construction at EY Americas. “If it goes to our data centers or our industrial buildings that power e-commerce, they’re doing pretty well. If you get into the multi-family business, rents might soften a bit, but there’s still an undersupply of housing. The elephant in the room is office space, which is undergoing a transformative change.”
When it came to office loans, as of 2021, 44% more by volume was in default and 55% more in specialty services, according to Trepp, a provider of commercial real estate data and information.
“Storm clouds are absolutely building,” Grinis says.
Private capital to the rescue of office buildings?
In the near term, buildings that are poorly structured, capitalized, and financed are likely to see some sort of change of ownership or be foreclosed on, Grinis says.
“You’re going to see some cracked eggs as these (mortgage) things mature and come due,” Grinis says. “And they have to find someone to give them additional equity, they have to make their lender flexible or it will go back to the bank.”
When the price is right, expect private capital to step in.
“It’s a publicly traded stock and a lot of people look at some of these office stocks and say, ‘Gosh, these are a pretty good buy,’ so private equity, at some point when the price is right, will be there. . ”
Perspective of a real estate company
Kip Sowden, chief executive of Dallas-based RREAF Holdings, a private real estate investment firm with $5 billion in assets under management, says he has seen business shrink due to tighter credit requirements.
The company, which operates in 14 states, develops multi-family homes, beachfront resorts, large residential communities, extended-stay hotels and is in the process of developing RV parks.
In 2022, the company surpassed $1.5 billion in transaction volume, up from $1.3 billion in 2021, he said.
“And in 2023, we think those numbers will probably halve due to higher interest rates and just a contraction in the number of deals that financial institutions will be looking to fund.”
Sowden, who borrows from regional banks, says underwriting requirements have become very strict.
“It takes a lot more capital to transact than before,” he said.
Office-to-home conversions are top of mind
Office-to-residential conversions have been a hot topic of discussion ever since the pandemic emptied office buildings.
State and local officials can help developers stick with languishing properties while addressing affordable housing challenges in cities by expediting the zoning changes needed for these conversions, experts say.
“Cities like New York and San Francisco are jewels in the urban landscape, and no one benefits when these urban centers suffer,” Grinis says. “So there is a call to action with respect to governments, private capital and then, to some degree, regulators and legislators to ensure that the vibrancy of cities continues.”
Swapna Venugopal Ramaswamy is a housing and economics correspondent for USA TODAY. You can follow her on Twitter @SwapnaVenugopal and sign up for our Daily Money newsletter here.
This article originally appeared on USA TODAY: Morgan Stanley Commercial Real Estate Report Predicts Sharp Price Drop