CMBS Demand Is Rising Amid Mounting Delinquencies

Issuance could be twice last year’s, but trouble is still brewing for existing bondholders.

The Commercial Mortgage-Backed Securities market is experiencing an upswing in investor demand and deal volume despite rising CMBS delinquencies. Experts predict 2024 issuance will double last year’s volume.

Of course, CMBS activity was meager last year. Only $39.3 billion in CMBS was issued in 2023: $19.7 billion of conduit and $19.6 of single-asset, single-borrower, according to Gantry. But, with $17.2 billion of conduit and $11.5 billion in SASB issuance by mid-March, the mortgage banking firm anticipates $60-$70 billion of CMBS issuance this year: $25-$30 billion in conduit and $35-$40 billion in SASB.

READ ALSO: Borrowing and Lending Expected to Reach $576B in 2024, Says MBA

Meanwhile, Fitch Ratings reported that delinquency in commercial real estate loans is expected through 2025 for CMBS, U.S. banks and life insurers, with deterioration led by office properties, and weakening across other asset classes.

The duality in the CMBS market is the result of clean underwriting and the addition of multifamily CMBS financing, on the one hand, and the impact of higher interest rates, tighter lending policies amid declining occupancies and maturing loans, on the other hand. 

Issuance was broadly distributed across all asset classes in 2023, with office comprising 11.1 percent of deals, retail 28.3 percent, multifamily 5.1 percent, hotel 21.5 percent, industrial 14.0 percent, and mixed-use/other 19.9 percent.

“There is strong demand from CMBS bond investors because they like that new underwriting is thorough,” noted Gantry Principal Mark Ritchie. “These projects are cash flowing at higher interest rates, and financing multifamily assets, which at scale is a positive and a new phenomenon.”

The quality of the new issues is reflected in the pricing.

“Spreads have come in, and there is investor appetite across CMBS tranches—from AAA to BBB,” added Aaron Jodka, director of research for U.S. Capital Markets, at Colliers, noting that issuing new paper provides liquidity in the lending market. He suggested that willingness of shops to underwrite SASB deals, as well as bundle multiple properties into an issuance, is driving investor appetite for CMBS.

And it’s not just multifamily that investors have an appetite for. Last month, Worthe Real Estate and Stockbridge secured a $475 million CMBS loan on the Warner Bros. HQ in Los Angeles. It was the largest office SASB since 2022, and it was perceived as a sign of a strength for both Class A office and for CMBS.

Most CMBS deals, though, are being underwritten at 2024 valuations, Ritchie noted. “One should never underestimate the creativity of CMBS and Wall Street,” he commented. “They’ve successfully underwritten not only traditional but also alternative assets in the CMBS space. However, office building financing in general remains a challenge.”

With CMBS shops’ moving to a five-year fixed rate debt term, this financial product has become a viable alternative to bank or agency financing, Ritchie continued. He attributes this year’s CMBS resurgence to its ability to meet the requirements of those in need of debt capital to maintain asset cash flow.

Tale of two CMBS markets

At the same time, however, many owners are having trouble meeting their obligations, and refinancing is difficult.

“The overall U.S. CMBS delinquency rate increased by 5 basis points to 2.28 percent in February 2024 from 2.23 percent in January due to the continued high volume of new delinquencies, including larger balance mixed-use and office loans,” said David Ro, director of CMBS at Fitch.

New 60-plus day delinquency volume totaled $1.16 billion in February, up from $1.06 billion in January, with office and mixed-use loans accounting for the largest share of new delinquencies, 42 percent ($492 million) and 37 percent ($425 million), respectively. Term defaults accounted for 56 percent ($654 million) of new delinquencies, while maturity defaults represented 44 percent ($508 million).

Office represents the biggest share of CMBS delinquency at 6.63 percent. “We anticipate office will continue to be under pressure due to a convergence of work-from-home-induced demand shock, higher borrowing costs, and a pullback in lending,” Ritchie said.

The 80 basis point surge in the mixed-use delinquency rate in February, Ro noted, was driven primarily by the $215 new loan delinquency for 681 Fifth Avenue, which is owned by Metropole Realty Advisor Inc.

“The loan, which transferred to special servicing in September 2023, is secured by an 82,573-sf mixed-use property with retail and office components in Midtown Manhattan and was formerly the global flagship location for Tommy Hilfiger,” Ro said. 

READ ALSO: Office Distress Reopens the CMBS Bargaining Table

The other two largest delinquencies involved a $134-million loan on 1615 L Street, a 417,383-square-foot office building in downtown Washington, D.C., and an $80-million loan on Central Park of Lisle, a 693,606-square-foot suburban office complex in Lisle, Ill., which became lender-owned in February.

Fitch analysts noted in a report that the overall U.S. CMBS loan delinquency rate is projected to increase to 4.50 percent in 2024 and 4.90 percent in 2025. Office delinquency is expected to more than double to 8.1 percent in 2024 from 3.48 percent in November 2023 and reach 9.9 percent in 2025—surpassing the historical peak of 8.8 percent in September 2012.

Retail and hotel delinquency rates are projected to rise significantly in 2024, as softness in consumer spending and declines in leisure travel create refinancing difficulties for the larger volume of maturities over the next two years, but delinquency should decline slightly in 2025 as the macroeconomy stabilizes and interest rates fall.

The multifamily delinquency rate also is expected to double in 2024, given heightened levels of new supply, slowing revenue growth, and higher expenses affecting property net cashflow.

There are two causes for higher CMBS delinquency over the next two years, according to Ritchie. “I see this as two separate issues: maturity defaults where, even if there is enough cashflow, there aren’t options available at the current capital stack, and non-maturity defaults where the tenancy/cash flow can’t support the current debt,” he explained.

The outcomes for non-maturity defaults are dependent on the lender and sponsor’s commitment to an asset, Ritchie noted, which may include additional capital being invested in the project.

According to MBA data, $340 billion in CMBS and other conduit loan products will mature in 2024 and 2025.  Fitch analysts noted that the total includes more than $31.2 billion of non-defaulted and non-defeased CMBS loans scheduled to mature this year and an additional $37.9 billion in 2025.  

Combined, this is approximately 15 percent of the Fitch-rated conduit and agency universe by balance and higher than the $26.5 billion that matured between October 2022 and December 2023.

Rate relief in sight

The three interest rate cuts forecasted by the Fed for this year might ease the pressure on CMBS bonds.

“Now that the Fed has confirmed three rate cuts this year there is more certainly and clarity on where rates are going,” Jodka said. “Easing rates should lower the cost of debt across lending options and increase the value of existing CMBS issues,” he added, noting that values move counter to rates—lower rates typically equate to higher values.

Furthermore, Jodka contended that rate cuts will be a boost to liquidity and issuance overall. “So while delinquencies are rising, particularly for office, the macro trends for rates and demand/need for debt capital is likely to win out, resulting in higher 2024 CMBS issuance,” he continued.

However, Ritchie noted that markets are struggling to define how lowering short-term rates will impact long-term rates. “The Fed is focused on its Fed Funds Rate, or overnight rate, which drives the cost of short-term debt,” he explained, noting that this rate will still be higher than 10-year treasury issues, which is how most long-term debt is priced.

”So we have a ways to go before the FFR will be back to normal levels, compared to 10-year treasuries,” Ritchie continued. “For the 10-year treasury to drop significantly, there would need to be a larger corresponding drop in the FFR—beyond anything talked about now or an existential event that would cause treasuries to drop.”

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