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CRE Distress Tracker Hits Decade-High Of $107B

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MSCI’s U.S. distress tracker for Q4 2024 reached $107.0 billion, marking a significant 24.3% jump—or $20.9 billion—from the previous year. This is the biggest annual increase in a decade, though it’s still just over half the peak seen during the Global Financial Crisis. Looking ahead, this figure sets the stage for 2025.

On a positive note, the pace of distress growth has been easing since Q4 2023. In simpler terms, while distress is still rising, it’s doing so more slowly—the rate of acceleration is tapering off. Markets might prefer an instant drop in distress, but this slowdown is a critical and necessary step worth noting.

It’s also worth distinguishing between the total value of distressed assets and their sheer number. While large distressed loans grab attention, they don’t always signal a broader trend. MSCI pointed out that by the end of 2024, the number of distressed properties was only about a quarter of what it was at the height of the GFC.

Breaking it down by sector, office properties led the pack with $51.6 billion in distress—nearly half the total. Retail followed at $21.4 billion, multifamily at $17.1 billion, hotels at $12.7 billion, other categories at $2.6 billion, and industrial at $1.7 billion. Despite ranking third, multifamily was the main force behind the overall distress growth in Q4.

In commercial real estate circles, many have been waiting for distressed property sales to become a major opportunity. MSCI reported that these sales made up 2.5% of last year’s total deal volume—modest but notable as the highest share since 2015. For perspective, that figure hit nearly 18% back in 2010.

Looking at potential distress—issues like tenant struggles or property liquidations—offers another layer. Office properties face $74.7 billion in potential distress, but multifamily tops the list at $108.7 billion, accounting for 34.9% of the total risk pool.

The dynamics differ sharply between office and multifamily. Hybrid work has emptied out many offices, driving up vacancies and leaving owners scrambling to cover costs. Multifamily, on the other hand, isn’t seeing a wave of vacant units—people still need places to live, even if landlords hit rough patches. This contrast could make the distress picture trickier in the months ahead.

 

Source:  GlobeSt.

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Property Type and Vintage Matter Most in Assessing CRE Loan Risks

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Since the downturn in 2022, there’s been a tendency to view commercial real estate and lenders as a single entity, but a recent MSCI report highlights that losses vary based on property types and loan origination timing.

For example, borrowers with long-term loans from 2015 likely have options to refinance due to prior price growth, while those who took short-term loans in 2022 face challenges when it comes time to refinance.

The report emphasizes that decision-making is often influenced by past experiences, but it cautions against using previous downturns as a guide for the current situation. Each downturn has unique conditions that must be considered.

MSCI analyzed over 6,400 lenders and assessed collateral values, noting that the current market is less concentrated than in past crises, which has contributed to a lack of expected distress in the market.

Although fundamental stresses exist—such as outdated office and retail spaces—many industrial properties still hold unrealized gains. Distressed assets are primarily being acquired by local operators familiar with the market rather than distant investors.

 

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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