Rising Default Risk on $1.5 Trillion of Commercial Real Estate Debt

Mortgage News April 18, 2023

According to analysts at Morgan Stanley, there is an increasing possibility of default in the commercial real estate market. This is because valuations of office and retail properties are expected to drop by up to 40%, and there is a significant amount of debt, approximately $1.5 trillion, that needs repayment before the end of 2025

The recent failures of banks, particularly Silicon Valley Bank and Signature Bank of New York, have further complicated the situation. These banks have historically extended credit to the $20 trillion commercial real estate sector and have recently faced substantial outflows.

According to Morgan Stanley analysts, the amount of debt in the commercial real estate market will continue to increase even beyond 2025. Over the next four years, there will be a peak in debt maturities of $550 billion in 2027 for commercial real estate properties. In addition to providing loans to these entities, banks also invest in commercial mortgage-backed securities, which are bonds backed by property loans and guaranteed by the federal government.

According to analysts at Morgan Stanley, banks are holding a significant portion, as much as 70%, of the commercial real estate loans that will mature over the next five years. The value of commercial real estate is declining due to the prevalence of remote work, which was initially introduced as a response to the pandemic and has continued in many parts of the country. In March, commercial real estate values in the US dropped by 15%, as reported by data provider Green Street. This decline in value was further compounded by the ongoing hybrid work trend, as well as high-interest rates, according to CNN.

Cohen & Steers’ head of real estate strategy, Rich Hill, has predicted that commercial property values may drop by up to 30% this year, which would make it harder for property owners to refinance. Banks may require property owners to provide more equity in such a scenario, which can be challenging. This situation could have a catastrophic impact on the banking industry

At the start of this year, Signature Bank of New York held the 10th largest collection of commercial real estate loans in the United States, as per Trepp data. Around $270 billion worth of commercial real estate loans held by banks are due to mature in 2023, and approximately one-third of these loans, which amounts to $80 billion, is for office properties.

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