A recent report from S&P Global Market Intelligence noted that large banks had more exposure to CRE loan risk than had been publicly perceived.
This has been a recognition building over time. In November 2023, it looked as though small banks were increasing their number of CRE loans while large banks turned more cautious. And all the statistics and monitoring metrics seemed to show that the biggest concentration of CRE loans was among small and regional banks.
But by mid-May this year, clearly something wasn’t adding up. Distress levels jumped while the extend-and-pretend practice of lenders continued. That certainly included large ones when the distress rate increase “was significantly affected by one large loan which impacted the segment distress rate in a fairly dramatic fashion,” according to CRED iQ. That magnitude of transaction is not one within the capacity of a small bank.
May also brought realization that banks have additional invisible exposure to CRE debt. A paper from researchers at the NYU Stern School of Business; Georgia Institute of Technology – Scheller College of Business; and Frankfurt School of Finance, CEPR argued that extensions of credit lines to nonbank financial intermediaries (NBFIs), with REITs being a prime example, provided the potential for extensive backchannel exposure. Additionally, they said this less obvious relationship means larger banks face more risk from CRE than is generally assumed.
In June, the Federal Reserve announced that its annual stress tests showed the largest US banks to have sufficient capital to withstand severe economic and market turmoil. That supposedly included any potential shock that a significant drop in commercial real estate values could deliver.
But in a highly unusual move, JPMorgan Chase released a commentary on the Fed’s review and, specifically, the central bank’s projections for Other Comprehensive Income, or OCI. The CFA Institute explains that a bank’s OCI statement is “where valuation changes of interest rate risk-sensitive debt instruments are reported.” Many investors don’t regularly monitor such information. More generally in accounting, OCI includes unrealized gains and losses.
As JPMorgan wrote, “Based on the Firm’s own assessment, the benefit in OCI appears to be too large. Should the Firm’s analysis be correct, the resulting stress losses would be modestly higher than those disclosed by the Federal Reserve. “
In June, the question arose of whether bond credit ratings were as trustworthy as investors had thought. The history of the Global Financial Crisis should remind of how questionable ratings can lead to financial disaster.
Recently, plummeting property values in transactions raised questions of whether borrowers illegally manipulated financials and property valuations to gain loans. Details from the S&P Global report pointed to the weakest point for large banks: loans on nonowner-occupied properties.
Delinquencies and net charge-offs used to be higher on owner-occupied CRE properties, but that switched in recent years. Nonowner-occupied property loan performance worsened in 2023. Large banks — those with $100 billion or more in assets — saw nonowner-occupied loans hit a delinquency rate of 4.41% by March 31, 2024. The rate for owner-occupied properties was 0.98%. The net charge-off rate was 1.13%.
S&P Global put together a collection of the top 25 banks by highest concentrations of loans on nonowner-occupied CRE properties. The median metrics were 23.6% of total loans and leases were CRE. That ranged from 2.9% (Goldman Sachs) to 52.1% (Provident Financial Services).
Nonowner-occupied percentages of the CRE loans were 76.4%. That ran from 69.1% (JPMorgan Chase) to 97.9% (Morgan Stanley). And the median delinquency percentage and net-charge off percentage were respectively 0.97% and 0.07%. The former ranged from 0.06% (Ameris Bancorp) to 8.55% (Goldman Sachs). The latter, from -0.01% (Valley National Bancorp and United Bankshares) to 7.88% (CIBC Bancorp).
Source: GlobeSt.
Plummeting Valuations Kick Up Fraud Allegations
There’s a significant upswing of commercial mortgage fraud according to a Wall Street Journal report. Federal prosecutors are chasing down cases of borrowers who illegally manipulate financials and property valuations.
That’s creating concerns across the ecosystem, with lenders and investors likely sources of the bigger worries. Fraudsters, cheaters, and cons aren’t a new invention. They exist in every industry and undertaking, usually represent a small portion of activity, and can be planned for.
Real danger comes when regular market participants are hot to close deals when things are busy and then conditions change. Falling valuations and transactions coupled with higher interest rates and a CRE mortgage maturity wave put many into risky and uncomfortable situations. As Warren Buffett has famously said, when the tide goes out you can see who was swimming naked.
A few years ago, pandemic-era easy monetary policy meant to rescue the economy pumped enormous amounts of liquidity into all sorts of markets. Commercial real estate was one of them. Capital poured in, valuations jumped, and many investors and funds new to CRE began bidding up prices. Interest rates were low, available leverage was high, and there were profit incentives to seek high valuations with the chance of pulling out capital for profit or other investments.
The fall in valuations is significant. When the value of a property drops precipitously from an earlier valuation, the differential affects the ability to sell with a profit or to refinance a property.
In CRE, such moves can be remarkably easy, given how the industry works. According to the Journal, it’s the hands-off process of determining property valuations.
Due diligence also takes time. In a competitive landscape, lenders often want to move quickly to close deals when they’re available. When things slow down, like the last two years, and conditions change, the corner-cutting eventually rises to visibility.
That’s become obvious. Banks of all sizes, are getting hurt by the percentage and quality of assets tied up in CRE. That even includes the largest ones. S&P Global Market Intelligence analyzed Q1 regulatory findings. They found that while giant banks had lower percentages of CRE loans in total, but those had higher percentages of loans that were either delinquent or nonaccrual.
This is why lenders want to know what is happening in their portfolios. Which loans will be safe, which could be headed for problems, which can be given the extend-and-pretend treatment, and which ones should be referred to legal authorities.
Source: GlobeSt.
Skyrocketing Multifamily Expenses Are More Than Insurance
A year ago, Moody’s research said expenses like insurance, utilities, and property taxes could experience inflation that exceeds revenue growth, straining net operating incomes.
The situation hasn’t improved in 2024, according to Moody’s latest analysis. Multifamily valuations are tied to revenue growth and management of operational expenses. Costs have become a critical factor for owners given that annual effective revenue growth is expected to stay below 2% this year. Growth of expenses over revenues puts pressure on NOI, which is key to valuations. And valuations support the ability to refinance.
As expenses have increased, landlords have raised rents so revenue can balance out expenses and the average operating expense ratio has remained at about 45% in recent years, including pre-pandemic. That leaves renters to bear the burden, Moody’s wrote. And when rents push up faster than in the past, so does the shelter portion of inflation, which then helps keep overall inflation higher than the Federal Reserve’s target range, meaning that interest rates also remain elevated. With higher delivery of new multifamily inventory, expecting rent growth to continue with greater supply and less demand is unrealistic.
Source: GlobeSt.
Investors Scooping Up Strip Malls
While big-box or grocery-anchored shopping centers remain attractive, investors are taking an increasing interest in smaller community retail sites — a sector once dominated by wealthy families and private offices, reports Joe Ilardi of the Baltimore Business Journal.
FOR EXAMPLE: Take Foxtail Center in Lutherville, Maryland, for instance. Tenants include a mix of chains and local spots, and the site was owned by longtime Baltimore Orioles owner Peter Angelos. In 2023, however, Angelos sold the strip mall to a subsidiary of Ohio-based SITE Centers Corp. for $15.1 million.
BIG PICTURE: The transition from private owners to larger and in some cases public investors is ongoing across the country. The pandemic was a “battle test,” and shopping centers passed, said CBRE Executive Vice President Ryan Sciullo. Cushman & Wakefield found in a recent report that for the first quarter of 2024, the national retail vacancy rate was 5.4%, one of the lowest rates since before the 2008 financial crisis. Office vacancies, meanwhile, sit in the double digits. The income and value generated by many retail centers also managed to outpace interest rates, a key factor driving their widespread recognition as sound investments compared to other asset classes.
Source: SFBJ
Here’s Where The Big Bank CRE Pains Are Greatest
A recent report from S&P Global Market Intelligence noted that large banks had more exposure to CRE loan risk than had been publicly perceived.
This has been a recognition building over time. In November 2023, it looked as though small banks were increasing their number of CRE loans while large banks turned more cautious. And all the statistics and monitoring metrics seemed to show that the biggest concentration of CRE loans was among small and regional banks.
But by mid-May this year, clearly something wasn’t adding up. Distress levels jumped while the extend-and-pretend practice of lenders continued. That certainly included large ones when the distress rate increase “was significantly affected by one large loan which impacted the segment distress rate in a fairly dramatic fashion,” according to CRED iQ. That magnitude of transaction is not one within the capacity of a small bank.
May also brought realization that banks have additional invisible exposure to CRE debt. A paper from researchers at the NYU Stern School of Business; Georgia Institute of Technology – Scheller College of Business; and Frankfurt School of Finance, CEPR argued that extensions of credit lines to nonbank financial intermediaries (NBFIs), with REITs being a prime example, provided the potential for extensive backchannel exposure. Additionally, they said this less obvious relationship means larger banks face more risk from CRE than is generally assumed.
In June, the Federal Reserve announced that its annual stress tests showed the largest US banks to have sufficient capital to withstand severe economic and market turmoil. That supposedly included any potential shock that a significant drop in commercial real estate values could deliver.
But in a highly unusual move, JPMorgan Chase released a commentary on the Fed’s review and, specifically, the central bank’s projections for Other Comprehensive Income, or OCI. The CFA Institute explains that a bank’s OCI statement is “where valuation changes of interest rate risk-sensitive debt instruments are reported.” Many investors don’t regularly monitor such information. More generally in accounting, OCI includes unrealized gains and losses.
In June, the question arose of whether bond credit ratings were as trustworthy as investors had thought. The history of the Global Financial Crisis should remind of how questionable ratings can lead to financial disaster.
Recently, plummeting property values in transactions raised questions of whether borrowers illegally manipulated financials and property valuations to gain loans. Details from the S&P Global report pointed to the weakest point for large banks: loans on nonowner-occupied properties.
Delinquencies and net charge-offs used to be higher on owner-occupied CRE properties, but that switched in recent years. Nonowner-occupied property loan performance worsened in 2023. Large banks — those with $100 billion or more in assets — saw nonowner-occupied loans hit a delinquency rate of 4.41% by March 31, 2024. The rate for owner-occupied properties was 0.98%. The net charge-off rate was 1.13%.
S&P Global put together a collection of the top 25 banks by highest concentrations of loans on nonowner-occupied CRE properties. The median metrics were 23.6% of total loans and leases were CRE. That ranged from 2.9% (Goldman Sachs) to 52.1% (Provident Financial Services).
Nonowner-occupied percentages of the CRE loans were 76.4%. That ran from 69.1% (JPMorgan Chase) to 97.9% (Morgan Stanley). And the median delinquency percentage and net-charge off percentage were respectively 0.97% and 0.07%. The former ranged from 0.06% (Ameris Bancorp) to 8.55% (Goldman Sachs). The latter, from -0.01% (Valley National Bancorp and United Bankshares) to 7.88% (CIBC Bancorp).
Source: GlobeSt.
Single-Tenant Net Lease Cap Rates Rise
While 2023 was not kind to net lease, things have been improving so far in 2024, particularly for single-tenant.
A new report from the Boulder Group says that in the second quarter of 2024, single-tenant net lease saw cap rates increase for the ninth consecutive quarter. That was for all three sectors, with retail hitting 6.47% (up five basis points), office up 7.67% (an increase of seven basis points), and industrial at 7.10% (eight basis points up).
Things have been improving since the middle of Q2. In May, Marcus & Millichap said single-tenant net lease was in good shape. They pointed to the continued strength of the labor market and says that has supported increases in retail spending beyond inflation for real growth. Real increases in wages also helped by giving people on average more money to spend after price inflation.
The Boulder Group also noted that property supply had increased by 8.7% over the first quarter. Q2 also saw the largest number of properties on the market since 2021 Q4. For retail, the amount of inventory increased quarter over quarter by 8.1%. Office was up 11.4% and industrial, 9.5%.
Investors have shifted their positions. They largely think that the market currently favors buyers, which would fit with the ongoing increases in cap rates. That is particularly true for commoditized properties. Buyers have little competition and, as a result, are largely focused on either tax-free states or regions with strong demographic drivers. They’re also looking for CRE fundamentals and tenants with good credits. Stronger brands — Olive Garden and Texas Roadhouse, Boulder gave as examples — haven’t seen increases in cap rates.
Breaking results down even further, the auto sector has seen a five-point increase in cap rate. Median asking cap rates vary by lease term remaining. So, an auto service location with 16 to 20 years left has a 5.50% cap rate, but a 7.15% one for five years or less.
Casual dining saw an eight-basis point increase in general. But the rates varied from 5.25% for a Texas Roadhouse ground lease to 7.25% for either a Buffalo Wild Wings or an iHOP. Median asking cap rates ran from 6.05% for 16 to 20 years left on the lease to 7.30% for five years or less.
Dollar stores ran from 6.75% for Dollar General to 7.80% for Family Dollar. Net lease drug stores have seen some tough times for Walmart, Ride Aid, and Walgreens. The overall sector saw asking cap rates of 6.67%. But even if particular locations are threatened, the quality of the real estate that drug stores have accumulated is good, meaning owners should be in good shape, even if a store pulled out, as there will be plenty of other opportunities.
Source: GlobeSt.
Loan Modifications Nearly Double In 12 Months
Loan modifications have been jumping according to data from CRED iQ and are on track to expand beyond the record in 2023.
As of the end of May 2024, about $22 billion in loans received modifications by lenders. Just in 2024, there were $9 billion in modifications, “placing 2024 squarely on a path to a record-setting year of loan modifications.” In 2023, the total modifications were $16.8 billion. The average monthly volume of modifications was $1.8 billion, with April seeing the highest volume of $3 billion.
Three categories of loans — agency, CMBS conduit trusts, and single-borrower large loan (SBLL) securitizations look to be on pace to equal their activity in 2023. CRE CLO, though, looks as though it will easily pass its 2023 modifications.
This is the continuation of “extend and pretend” the markets have been seeing, despite the recent trend of large banks seeking to quietly offload portions of commercial real estate portfolios to avoid losses when office property owners can’t pay off mortgages.
CRED iQ pointed to two specific modifications as some of the largest. One was Phoenix Corporate Tower. The 457,878 square foot office backs a $33.7 million loan that was originally $38.0 million. The loan was modified in April 2024, pushing it out to July 2025.
The other example was the Retreat at Riverside, a 412-unit multifamily property in Atlanta that backs a $63.9 million loan, also modified in May 2024. That only extended the loan to July 2024.
Source: GlobeSt.
It’s Time For Investors To Get Off The Sidelines
Recent U.S. economic news has shown nothing if not uncertainty about the future. Here are some examples that happened within a few weeks of each other:
The June FOMC meeting’s economic projections showed current median sentiment that there might be only one rate cut in 2024. That isn’t policy and Federal Reserve Chair Jerome Powell said decisions are ultimately data dependent. There could be two cuts, or one, or, depending on new data, none until sometime in 2025.
More importantly, it doesn’t matter. Even two cuts would only represent be a drop of 50 basis points — hardly something to drive momentous new activity. Business was possible in much worse times. At its peak in January 1981, the effective federal funds rate hit 19.08%. The low in the ’80s was only 5.89% in October 1986. Remember the movie “Wall Street” and the phrase “greed is good?” It came out in 1987 when the low rate for the year was 6.10%, the high was 7.22% and actual CRE lending was much higher. Still, people made a lot of money.
We could discuss Elisabeth Kübler-Ross and her stages of grief. Many investors, owners, lenders and brokers have been upset for good reason. Valuations and transactions are down significantly. Past decisions to load up on cheap credit made refinancing a challenge now.
The first six stages of grief are past. Now is the time for acceptance. Don’t wait for future financial conditions to improve to look for deals. That invites serious opportunity costs. Not in the accounting sense for later analysis to see if your strategy was sensible, but in the true avoidable loss of future revenue and business relationships. In the ability to profit from investing capital rather than letting them lose value to inflation. Finding a stronger investment than parking cash in Treasurys and hoping that yield changes don’t undermine their value, so you have to hold to maturity or take a loss. Helping support the entire CRE ecosystem and your business partners for the future. And being ahead of the crowd when things improve, not trailing behind.
Your immediate past decisions might be painful to contemplate, but the right attitude and approach is to look and move forward. Assume, at least for now, that business conditions have changed, that there’s been a reversion to the long-standing mean. Recreate your strategy and deal-making to be effective under current conditions. It’s time to dust off and start moving once again. And if conditions do improve, you’ll be even better off.
Source: CPE
Sperry – RJ Realty’s Ron Osborne Reps Seller And Buyer In Purchase Of Automotive Facility In Ft. Lauderdale
Ron Osborne, Managing Director/Broker of Sperry – RJ Realty, represented the Seller, Repair Business Holdings LLC, and the Buyer, 1543 S STATE RD 7 LLC, in the sale and purchase of 1543 S. State Road 7 in Ft. Lauderdale, Florida.
The Seller was looking for a long-term sale-leaseback, however, the ultimate buyer is an end-user. The parties agreed to a one-year lease to allow the seller time to relocate his business.
The property is currently being utilized as a transmission shop.
Sperry – RJ Realty has represented both parties previously in unrelated transactions.
The buyer will ultimately use the property as an automotive repair business that will serve both the public as well as the vehicles from his own independent car dealership located on Oakland Park Blvd.
The property sold for $1,575,000. The buyer obtained a loan of approximately $1,100,000 from American National Bank, which was represented by loan officer Jeffrey Martin.
Osborne has been working the Broward County Market since 1978 and is a top producer in the Sperry Commercial Global Affiliates (SPERRY) network.
CRE Loan Distress Hits Third Consecutive Record
Distress hit a new record for the third consecutive month according to a new report from CRED iQ. It was up 14 basis points in May and reached 8.49%.
The delinquency rating includes “all CMBS properties that are securitized in conduits and single-borrower large loan deal types” but not Freddie Mac, Fannie Mae, Ginnie Mae, and CRE CLO loan metrics, which are treated in separate analyses.
CRED iQ calculates distress levels by looking at both delinquency and specially serviced rates.
Most property types are flashing red as distressed rates run from 7.1% in multifamily (improved by 10 basis points month over month), 11.1% in office (better by 60 basis points), 11.3% in retail (better by 60 basis points), and 9.4% in hotel (worse by 70 basis points). Industrial was at 0.5% (10 basis points worse) and self-storage, 0.1% (flat).
This being about CMBS, one single event can have an outsized effect on the whole picture.
Of the loans, 24.4% are currently, 2.0% are late but in the grace period, and 5.5% are late but less than 30 days.
Source: GlobeSt.
Sperry – RJ Realty’s Ron Osborne Reps Buyer In Purchase Of Central Florida Medical Office
Ron Osborne, Managing Director/Broker of Sperry – RJ Realty, represented the Buyer, GCDC Orlando LLC, in the purchase of a medical office located at 4980 E Irlo Bronson Memorial Highway in St Cloud.
PD ST. CLOUD LLC sold the medical office building for $5.3 million.
The newly constructed build-to-suit property was built for Sanitas Medical Center, which currently occupies the property. The Tenant signed a 10-year lease with over 9 years remaining with an annual increase at the time of the sale.
Sanitas operates 6 other locations in greater Orlando and has 68 medical facilities throughout Florida, Texas, Tennessee, Connecticut, and New Jersey.
Osborne also arranged for the financing of the acquisition with FirstBank Florida. Jeff Goldstein, Vice President, Business Relationship Officer, represented FirstBank Florida in the transaction, with 50% down at an attractive interest rate of about 7%. Osborne has a long-standing relationship with FirstBank Florida along with other lenders.
Osborne stated that the Buyer is still looking for great opportunities to acquire additional assets this year.
The property was represented by Jeffrey Cicurel with JLL’s Miami office.