Commercial Foreclosures Up 117% Year Over Year

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The number of commercial foreclosures in the U.S. has steadily increased, from a low of 141 in May 2020 to 625 in March 2024, according to an updated report from ATTOM.

That represents a 6% increase from the prior month and a 117% increase from last year. The real estate data tracking firm also noted that California, New York, and Florida were the states with the most foreclosures.

New York had a total of 61 commercial foreclosures in March 2024, a 5% increase from the prior month and a 65% increase from a year ago. Florida saw increases of 30% and 107%, respectively. Texas saw increases of 31% and 129%, and New Jersey saw increases of 31% and 133%.

Foreclosure filings on commercial real estate property in California in January 2024 were triple the number of foreclosures in January 2023, according to ATTOM data. Banks in California have a great deal of exposure to commercial real estate with 31% of Golden State bank portfolios carrying three times larger loans than capital.

The recent increase in foreclosures follows a multi-year low of just 141 in May 2020, reflecting the immediate impacts of the pandemic and swift response measures like moratoriums and financial aid for owners.

“Despite challenges like the COVID-19 pandemic and evolving economic policies, the market demonstrated remarkable adaptability,” ATTOM reported. “Initial pandemic-related foreclosures were followed by a stabilization as businesses adjusted to new realities.”

 

Source:  GlobeSt.

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STNL Cap Rates Won’t Be Coming Down Soon

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Cap rates for the single-tenant net-lease sector increased for the eighth consecutive quarter in Q1 2024, jumping to an average of 6.64% across all major asset types.

STNL asking cap rates for office properties hit 7.6% in Q1, followed by industrial, which averaged 7.02%, and retail, which jumped to 6.42%, according to the latest market report from The Boulder Group.

According to The Boulder Group’s Jimmy Goodman, the current cycle of STNL cap rate increases is the longest since 2014. In an interview at GlobeSt.’s Net Lease conference in NYC this week, Goodman said STNL cap rates will remain elevated until the Fed starts cutting interest rates.

“I think we’re at status quo, this is the new normal until the Fed moves to cut rates,” Goodman said. “Everyone had this level of hope last year that we would have rate cuts this year, but 2024 is looking a lot like 2023.”

“Now, people are hoping for a rate cut in Q3, but it probably won’t be a large cut,” he added. “Until then, nothing will change. Cap rates will increase or plateau. I don’t see them decreasing any time soon.”

The new status quo also is likely to keep transaction volume at a minimum — one description we heard is “flatlining” — as buyers are few and far between and sellers refuse to reprice their deals to higher cap rates.

Most of the players in the STNL market are in it for the long-term, typically with 10- or 20-year leases, and they can wait out the down cycle, Goodman noted.

“It’s a steady cash flow. The lenders, the equity, they know they’re going to get a check from the tenant,” he said. “If a $2M Starbucks just got built, it’s got a 10-year lease and they know they’re going to get paid.”

Sellers are still in denial about bringing their pricing in line with the new status quo on cap rates, Goodman suggested.

“If you’re a developer, you still want to make money off your merchant developer deals. The public REITs and people that are subject to financing can’t pay the cap rates the developer wants, and the developer doesn’t want to be upside down,” he said.

“Everyone is staring at each other and nobody is blinking,” Goodman added.

 

Source:  GlobeSt.

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Treasurys Get Harder To Sell And That’s Not Good For CRE

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In the latter half of last week, yields on Treasury 10-years jumped, hitting 4.55% on Wednesday, moving to 4.56% on Thursday, and dropping down to 4.50% on Friday. By the end of Monday, it was 4.63%

If you ignore 2023 when rising interest rates had a heavy impact on Treasury yields, the last time the 10-year was in this range was in the fall of 2007, as the initial rumblings of what would become the Global Financial Crisis.

Markets are not seeing the trembling of an out-of-control housing market and the derivatives built on top of it. But the current shakings might be worse.

“A series of weak auctions for U.S. Treasurys are stoking investors’ concerns that markets will struggle to absorb an incoming rush of government debt,” the Wall Street Journal reported. “A selloff sparked by a hotter-than-expected inflation report intensified this past week after lackluster demand for a $39 billion sale of 10-year Treasurys. Investors also showed tepid interest in auctions for three-year and 30-year Treasurys.”

The worry among investors is that if inflation doesn’t continue to sink, the Federal Reserve will keep interest rates where they are now rather than start cutting as investors have wanted. Or maybe increase rates if they decide it’s necessary to break the back of rising prices.

May will bring another $386 billion in bond sales, and, as the Journal notes, this will continue no matter who is elected president in November. The first quarter of 2024 saw the Treasury sell $7.2 trillion in debt. Last year, the government issued $23 trillion in Treasurys, “which raised $2.4 trillion of cash, after accounting for maturing bonds.” But a number of Treasury auctions did more poorly than expected. The Treasury Department decided to push short-term instruments as the Fed encouraged the idea that eventually they would cut interest rates. That would make higher-rate Treasurys more valuable in a presumed near term.

With inflation started to strengthen again, that strategy becomes less appealing to buyers. Also, the Fed has said it will slow quantitative tightening, which is how it reduces its balance sheet holdings of Treasury instruments. Tightening expects that investors would buy more debt. As the Fed reduces tightening, the government might lower its expectations of how much investors needed to buy.

From a CRE perspective, the more debt on sale, the greater degree that circumstances invoke the law of supply and demand. Prices will likely drop to get enough investor purchases, which would send yields up as the two aspects move inversely. The 10-year yield is one of the standard baseline rates used in CRE lending. The other, the Secured Overnight Financing Rate, or SOFR, is strongly correlated to the 10-year, though often with a timing gap.

If baseline rates go up, so do borrowing costs, which is the big problem faced by many with maturing loans and who need refinancing but who based their business case on low interest rates and high leverage that are no longer available.

And then there is the psychological factor. All investors, whether individuals, organizations, or sovereign states, are under the thumb of human emotion. The more risk they perceive, the more skittish they are as buyers, which could push down Treasury prices even more, driving up expected yield and negatively affecting CRE.

 

Source:  GlobeSt.

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Banks Have Another Reason To Scale Back CRE Lending

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The pressure that banks are feeling from CRE loans has become a regular observation by the Federal Reserve, Department of the Treasury, Federal Deposit Insurance Corporation, other regulators, economics, financial analysis, investors … pretty much everyone paying attention.

But there’s an odd twist according to a new analysis by economist and economic policy advisor Miguel Faria e Castro and senior research associate Samuel Jordan-Wood at the Federal Reserve Bank of St. Louis.

“Given the negative outlook on certain segments of CRE, one would expect that more-exposed banks have experienced worse market performances,” the two wrote. “We found that while CRE exposure has not mattered much for bank stock returns since the 2007-09 financial crisis, the correlation became significantly negative in 2023.”

The analysis started with an examination of the relationship between commercial real estate exposure as a share of total assets on one hand and total assets in billions of dollars, on a natural logarithm scale. Something immediately obvious is that the largest banks have a relatively small exposure in CRE loans as they represent 10% or less of their assets. But smaller to medium banks had high exposures, in some cases topping 60%.

They found that those banks with high exposure to CRE loans tended to have “relatively fewer liquid assets on their balance sheets, lower capital ratios (that is, more leverage), a larger share of their liabilities in the form of deposits, and a larger share of their assets in the form of loans.”

They then moved beyond a correlation analysis and used regression to look at the connection between CRE exposure and bank returns.

“From 2007 to 2008, the beta coefficient was statistically significant and negative, implying that banks with higher CRE exposure had lower stock market returns, all other variables equal,” they said. “Since the 2007-09 financial crisis affected not only residential real estate but also CRE, it is natural that more-exposed banks performed worse during that time. Our analysis reveals that while the correlation had been mostly inactive since then, it again became significantly negative in 2023.”

So, it seems to be another way banks are currently feeling negative effects from CRE exposure. Not just in concern over asset values and regulatory pressures, but in actual earnings.

 

Source:  GlobeSt.

 

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Some Experts Float the Possibility That the Fed Could Raise Rates Again

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Wednesday’s Consumer Price Index numbers were higher than expected, sending Wall Street into a swoon about what it could mean.

For starters, it’s just about a given that, following this latest evidence that prices are not declining as fast as had been expected, the Fed will delay implementing its promised rate cuts. But some prominent voices are wondering about a worse case scenario: that the Fed might actually start raising rates. If this were to come to pass, simply put it would raise havoc in commercial real estate. GlobeSt.com has heard repeatedly over the last few months that transactions were resuming in part because the market believed that the Fed was done raising rates, introducing some much-needed certainty into forecasts.

Former Treasury Secretary Lawrence Summers is one of these voices.

“You have to take seriously the possibility that the next rate move will be upwards rather than downwards,” Summers said on Bloomberg Television. He said such a likelihood is somewhere in the 15% to 25% range.

The odds still do favor a Fed rate cut this year, “but not as much as is priced into markets,” he said.

Also, Federal Reserve Governor Michelle Bowman said earlier this month that it’s possible interest rates may have to move higher to control inflation.

“While it is not my baseline outlook, I continue to see the risk that at a future meeting we may need to increase the policy rate further should progress on inflation stall or even reverse,” she said in a recent speech to the Shadow Open Market Committee in New York.  “Reducing our policy rate too soon or too quickly could result in a rebound in inflation, requiring further future policy rate increases to return inflation to 2 percent over the longer run.”

Bowman is a permanent voting member of the Federal Open Market Committee.

JPMorgan Chase CEO Jamie Dimon has also floated the possibility that rates could increase in his letter to shareholders. The investment bank is  preparing “for a very broad range of interest rates, from 2% to 8% or even more,” he wrote.

These voices, though, are in the minority. Right now, most analysts have coalesced around the theory that rate cuts will be delayed this year.

Less than 24 hours after the CPI was released, Wall Street economists began revising their outlooks. Goldman Sachs and UBS now see two cuts starting in July and September, respectively, while analysts at Barclays anticipate just one reduction, in September, according to the Wall Street Journal.

Others are even more pessimistic about the timing.

“The lack of moderation in inflation will undermine Fed officials’ confidence that inflation is on a sustainable course back to 2% and likely delays rate cuts to September at the earliest and could push off rate reductions to next year,” Kathy Bostjancic, chief economist at Nationwide, said in a research note that was reported by The Associated Press.

Right now the Fed’s official expectation is that inflation continues to move down albeit in an uneven trajectory. If this is true, then rate cuts are still likely this year.

However, Wall Street worries that inflation has stalled at a level closer to 3% and if the evidence bears this out in future reports, it is conceivable that the Fed could scrap cuts altogether.

One indicator that does not bode well for rate cuts this year is the so-called supercore inflation reading, which besides excluding the volatile food and energy prices that the core CPI does, also strips out shelter and rent costs from its services reading.

Supercore accelerated to a 4.8% pace year over year in March, the highest in 11 months, according to CNBC.

Tom Fitzpatrick, managing director of global market insights at R.J. O’Brien & Associates, told the publication that if you take the readings of the last three months and annualize them, the supercore inflation rate is more than 8%.

All this said, the Fed has promised it would cut rates three times this year and that is a hard promise to unwind. The upheaval a rate hike would cause would give the institution a black eye even worse than its promises a few years ago that the creeping inflation in the economy was transitory.

 

Source:  GlobeSt.

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Just How Big is the Wall of Maturities?

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According to Newmark, there is now a $2 trillion maturity wall of CRE loans facing banks over the next three years. A dizzying sum.

But the statement raises a question. When the size of the oncoming wall — or wave or lava flow, or whatever to call the coming flood — is mentioned, is anyone really sure of the size?

CRED iQ’s database at middle of December 2023 showed “approximately $210 billion in commercial mortgages that are scheduled to mature in 2024, with an additional $111 billion of CRE debt maturing in 2025. In total, CRED iQ has aggregated and organized a total of $320 billion of commercial mortgages slated to mature within the next 24 months.”

In February 2024, the Mortgage Bankers Association said that 20% of commercial and multifamily mortgage balances were to mature this year.

“Twenty percent ($929 billion) of the $4.7 trillion of outstanding commercial mortgages held by lenders and investors will mature in 2024, a 28 percent increase from the $729 billion that matured in 2023, according to the Mortgage Bankers Association’s 2023 Commercial Real Estate Survey of Loan Maturity Volumes,” they wrote.

Even discussions can be misleading. Take the Financial Times article. The headline is, “Banks face $2tn of maturing US property debt over next 3 years.” The immediate question becomes how much of banks’ portfolios are coming due? But to get there, it’s critical to see what the total holdings are.

According to the Federal Reserve’s “Assets and Liabilities of Commercial Banks in the United States,” also known as H.8, thetotal of commercial real estate loans, including multifamily, held by banks was $2,985.5 billion during the week of March 20, 2024. Given the timelines of loans, most frequently five-year cycles, a 20% turnover annually is a realistic estimate. But a $2 trillion count would be two-thirds of all bank loans, which doesn’t seem plausible.

GlobeSt.com contacted Newmark for some clarity. The firm responded with information from David Bitner, Newmark’s executive managing director and global head of research. Here are his points:

  • “The $2T figure should indeed refer to ALL CRE loans (including 5+ unit multifamily).”
  • “Bank maturities are the largest share of near-term maturities, which is a large part of why we focus on them.”
  • “Debt fund and CMBS/CRE CLO debt is also front-loaded.”
  • “Data comes from Mortgage Bankers Association latest Loan Maturities report (released in mid-February).”

So, the pool of loans is much larger than those held only by banks. Even with the “extend and pretend” treatment lenders seeking to keep losses off their balance sheets, eventually reality sets in. In one sense, it won’t matter who holds the loans. As accounting standards eventually force lenders to write off clear losses, the result would be a large exercise in mark-to-market, lowering the value of many if not all CRE loans.

That would hurt the total asset values of many banks, which is the condition that led to the closures of Silicon Valley Bank, First Republic Bank, and Signature Bank last year. As Gosin told the FT, such a result would force some banks “to liquidate their loans or find other ways to reduce their weight in real estate,” whether by finding ways to increase capital, offload the risk, or further reduce the amount of CRE lending they do.

 

Source:  GlobeSt.

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Loan Modifications More Than Doubled Last Year

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The move for lenders to find ways to avoid action on troubled CRE loans has been called “extend and pretend,” though “delay and pray” might be even more apt.

While an institution can avoid significant and final decisions, it can put off the day when it takes a hit to its balance sheet, hoping that find another solution in the meantime. Who wants to take possession of a property along with the responsibility of disposing of it?

But how much of this activity has been going on and how long could it be sustained? CRED iQ has analyzed loan modifications during this period of significantly elevated interest rates.

“The number of modifications in 2023 more than doubled compared to 2022,” they said. “Of the $162 billion in securitized commercial mortgages which matured in 2023, 542 loans were modified with cumulative balances just over $20 billion, which is a 150% increase from the amount of modifications that occurred in 2022. According to CRED iQ’s 2024 CRE Maturity Outlook, 2024 will see $210 billion in securitized maturities. CRED iQ predicts that the modification trend will continue to surge as more special servicers decide to ‘pretend and extend’ versus foreclose on these commercial properties.”

In office, 26% of $35.8 billion in CMBS loans that matured last year were paid in full. Borrowers either couldn’t get refinancing (which likely would have meant a heft injection of equity into projects) or couldn’t sell for a price that allowed them to gracefully exit the stage.

Since February 2022, so two years, 593 office loans transferred to special servicing. Out of them, 13.7% were modified, 14.0% returned to the master servicer as corrected, 8.4% were paid off, and the remaining 63.9% are still with the special servicer.

“Extending the loan term has been the most popular modification type in 2023 and so far in 2024 (excluding grouping categories Other and Combination),” they wrote. “By deal type, CRE CLO deal led all categories and comprised nearly half of all loan modifications, followed by SBLL deals.”

CRED iQ gave two examples of the largest loan modifications to date — 1.6 million square feet One Market Place in San Francisco and 249,063 square foot mixed use in the Chelsea submarket of New York City. Well enough, but how long can this go on without investors, regulators, or others demanding a permanent ending?

 

Source:  GlobeSt.

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Spread Between Corporate Debt and CRE Mortgages Hits 24-Year High

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In its recent look at U.S. capital trends, using the most recent data through 2023, MSCI look at what it called debt snapshots — a handful of considerations that help explain how troublesome CRE debt markets are at the moment.

The first was the spread between corporate debt and CRE debt and how it has risen to a high at least when looking at figures from the last 24 years. It was more relatively costly to finance a commercial property through a direct mortgage.

“The spread between commercial mortgage rates and corporate bonds widened to an average of 121 basis points over the last six months of 2023,” MSCI wrote. “Looking back to 2000, mortgage rates were at a comparable high relative to the cost of corporate debt only in the worst parts of the GFC. And even then, the spread was only at high levels for three months.”

After the Great Financial Crisis, the gap between corporate and CRE mortgage debt averaged only about 9 basis points between Moody’s Baa corporate bond yield and 7-year and 10-year commercial mortgage rates.

Connected to the cost is the perception of risk. According to Moody’s, the definition of Baa credit is, “Obligations rated Baa are judged to be medium-grade and subject to moderate credit risk and as such may possess certain speculative characteristics.” The added spread for CRE mortgage rates suggests that commercial mortgages are even riskier. Given market jitters and concerns about default, that shouldn’t be surprising.

Higher interest rates do put a sting into transactions and refinancing, but investment funds are feeling the pinch, MSCI said. “On the performance side, it has also had an impact on investor returns,” they wrote. “The MSCI/PREA U.S. ACOE Quarterly Property Fund Index ended 2023 with an annual net total return of -12.6%, and a pure leverage impact of -396 basis points (bps). The mark-to-market on outstanding debt contributed a positive 13 bps but this gain only slightly offset the pure leverage impact and means the total impact of debt was -383 bps.”

And when interest rates are higher than returns on investments, debt becomes dilutive. MSCI estimates that interest rates on outstanding debt went from 3.4% in June 2022 to 4.5% by December 2023. Property returns for the year were -8.3%.

“As a core fund index, leverage levels in the index are relatively low, with debt representing 25.7% of gross asset value as of the end of 2023, though this is up from 20.9% in March 2022, largely due to asset value declines. For funds outside the core space that carry higher debt loads, the dilutive impact of debt would likely have been felt even more acutely.”

So far, bank loan delinquency rates have been “rising, not surging.” However, as GlobeSt.com has separately reported, there have been questions of whether lenders have been indulging in “extend and pretend.” Stretching renewal dates means not having to take immediate hits on balance sheets. That can work for a while, but only so long.

 

Source:  GlobeSt.

 

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How Sale-Leasebacks Help PE Raise Capital In A Tight Market

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Funding for growth, refinancing corporate debt, and merger and acquisition activities are top priorities for many private equity firms. A recent PwC report noted that 60% of CEOs plan to make at least one acquisition in the next three years. The report further explains that lower levels of M&A activity during 2023 created “pent-up buyer demand” moving into the current year. However, tapping into capital isn’t always easy when it is locked in assets.

“It’s quite inefficient for private equity firms to have capital tied up in real estate assets that aren’t earning for them,” says Tyler Swann, managing director, investments at W. P. Carey. “An alternative is doing a sale-leaseback, which provides a much lower cost of accessing capital than traditional financing methods.”

Understanding sale-leasebacks and their advantages can help private equity firms strategically manage growth funding, debt maturities and other capital needs.

 

The Advantages of Sale-Leasebacks

With traditional financing strategies such as mortgages, terms are often shorter and exposed to higher market volatility. Accessing capital can also be time-consuming, a challenge for firms that need to move quickly for acquisition deals. That’s not the case with sale-leasebacks, notes Swann.

“Sale-leasebacks are very flexible,” says Swann. “The processing time can be as short as 30 to 45 days between the initial call and the actual funding. It’s not unusual for us to get a call from a private equity firm saying, ‘We’re closing on a business in 30 days; can you be there to close with us as acquisition financing?’ And that’s something we can do.”

He explains that capital uses also have very few restrictions, with the most common purposes being acquisition financing, dividend payments, and refinancing maturing debt.

 

Misconceptions About Sale-Leasebacks

As private equity firms consider sale-leasebacks, questions often linger regarding who qualifies for this type of financing. Many believe that because their real estate is in a secondary or tertiary market, or their asset doesn’t have a huge value, they won’t qualify. But according to Swann, that’s not necessarily true.

“If you have a specialized manufacturing facility in a small market, you may think it won’t qualify because it’s not a high-quality warehouse in a market like Southern California,” says Swann. “Despite where an asset is located, if it’s profitable and contributing to the bottom line of a business, it could be a great candidate for a sale-leaseback.”

As the market progresses through 2024, Swann expects sale-leaseback activity to continue upward, partly due to M&A activity and its flexibility to tap into capital quickly.

“Every year, sale-leasebacks become a little more accepted in the private equity community as a source of financing,” says W. P. Carey’s Swann. “Ten or 20 years ago, corporate debt was by far the dominant option, but we continue to see an increase in sale-leaseback deals every year.”

 

Source:  GlobeSt.

 

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How One Net Lease Giant Plans to Deal With Debt Maturities

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Debt maturities are a big consideration in all areas of commercial real estate, including net lease. The topic came up in most recent earnings call for Global Net Lease (GNL), one of the largest public REITs focused on net lease.

The reason for a focus on debt maturities and the connected topic of interest rates is because they put pressure on all CRE businesses. The stock price reflects concerns about macroeconomics and finance. There was a sharp plummet starting late February 2020, which makes sense given pandemic-related shutdowns of retail businesses. With the advent of successful vaccines, the price regained ground to within a couple of dollars by June 2022, and then came the Federal Reserve’s reaction to inflation — a series of sharp and quick rate hikes. And the stock started falling again, from $19.90 to $7.56 as of March 18, 2024.

The expected wave of CRE loan debt maturities is a problem across CRE. That includes net lease properties.

“GNL is implementing a 2024 business plan focused on deleveraging its balance sheet, reducing its exposure to variable rate debt and driving down its net debt to adjusted EBITDA,” said co-CEO Mike Weil during the most recent earnings call. “Our near-term strategic priority will focus on reducing leverage through select dispositions, prioritizing noncore assets and opportunistic sales.”

He further said that assets targeted for disposition include both non-core and those that have near-term debt maturities or implied-term lease expirations. The latter is important because the company focuses on investment-grade or near-investment-grade tenants, with 58% of their tenants in that category. Single-tenant retail represents two-thirds of the investment-grade or implied investment-grade tenants. If a significant portion of the lease expirations are among these tenants, turnover would put more financial pressure on the company.

The largest segment of their portfolio is industrial and distribution, and that segment has been seeing pressures of late that had once seemed to pass the category by.

“Total annual industrial leasing activity fell to 790 million sq. ft. in 2023 from a record 1 billion sq. ft. in 2021 and was not enough to offset the large amount of new supply,” wrote CBRE earlier in March. “As a result, the overall industrial vacancy rate jumped by 180 basis points (bps) last year to 4.8%, returning to near its 10-year average of 4.7%. Developers predictably became more hesitant to break ground and construction starts fell to 46.3 million sq. ft. by Q4 2023 from a quarterly average of 102.5 million sq. ft. in 2022.”

“GNL has a plan to address the remaining 2024 debt maturities through dispositions, refinancing and availability on the credit facility,” said chief financial officer Chris Masterson. “We will continue to address the 2025 maturities and anticipate that the second half of 2024 will present a more favorable environment for debt maturities beyond 2024, but we remain confident in our ability to refinance these assets.”

 

“We expect a total of $400 million to $600 million of strategic dispositions in 2024,” Weil said. “This disposition program will drive long-term shareholder value by generating cash to enhance and derisk our balance sheet and create a clear path forward for us to potentially narrow the trading discount compared to our net lease peers. Selling assets at attractive cap rates will also provide proof of value to investors and demonstrate a significant premium compared to where the company is currently trading on an implied cap rate basis.”

 

Source: GlobeSt.

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