Commercial real estate has had a few rough years, and it seems like things won’t be getting better anytime soon. The sector is set for a potential rise in defaults, as higher interest rates have increased the costs of refinancing.
And with $2.8 trillion due between now and 2028, more landlords could be feeling the crunch. According to data firm Trepp, commercial debt maturities are expected to balloon in the next few years. While many loans were extended or refinanced, the clock is slowly ticking for the CRE sector as those extensions are coming due.
Worst Commercial Slump in the Last 50 Years
The CRE market has been struggling to regain its footing since the start of the pandemic, especially in office space. When the pandemic hit, many office spaces emptied, forcing landlords to make deals to delay payments until things recovered.
Unfortunately for those invested in the office arena, remote and hybrid working is now becoming the norm, with many businesses downsizing their office space or even becoming fully remote.
Now that the CRE debt is coming due, landlords are starting to squirm. Because of how commercial mortgages are structured, when the debt matures, the principal must be paid off in full or refinanced.
This has led to one of the steepest commercial real estate price declines in the last 50 years, a group of economists at the International Monetary Fund (IMF) found. This can largely be attributed to higher interest rates, steep monetary policy tightening, and stricter bank lending standards, according to the IMF.
While the office sector has been the hardest hit, the entire market has felt the sting over the last few years thanks to a souring CRE market. Vacancy rates in multifamily homes have increased, and rent growth is expected to decline in the coming year, according to CBRE. Industrial spaces are also showing signs of weakening.
The only potential bright spot in CRE is the retail sector, as robust consumer spending and suburban migration has driven demand for outdoor shopping centers.
Interest Rates Aren’t Going Down Fast Enough
While interest rates have gone down a bit, it might not be enough. According to The Wall Street Journal, many borrowers are refinancing at rates higher than when they first took out loans.
The Federal Reserve is under pressure to cut rates, with some economists expecting a cut by the end of the year to 3.75%-4% and continued cuts by the first half of 2026 until the rate hits 1.75%-2%. However, that might not be fast enough for the CRE sector. Fitch Ratings expects delinquency rates in commercial real estate to increase to 4.5% this year, while regulators are worried about the spillover effects.
In its 2023 annual report, the Financial Stability Oversight Council (FSOC) cited exposure to commercial real estate as a concern for financial institutions and said that they need to better understand the risk. Nearly 50% of CRE’s outstanding debt is held by banks.
“As losses from a CRE loan portfolio accumulate, they can spill over into the broader financial system. Sales of financially distressed properties can… lead to a broader downward CRE valuation spiral,” FSOC said in its report.
The Bottom Line for Real Estate Investors
Commercial real estate investors should buckle in and get ready for a bumpy ride over the next few years. That said, although the CRE space is under pressure, there’s still some time for landlords to negotiate. Still, with CRE sales also under pressure, that’s devalued properties, making it hard for lenders and borrowers to agree on how much the property should be worth.
With banks becoming more risk averse around CRE and under more regulatory scrutiny, that could open opportunities for non-bank lenders such as private credit to step in. And for some savvy investors, the stress in the CRE market could provide opportunities.
In other words, there could be opportunities for investors to find distressed properties for a great value, provided they’re prepared to weather some uncertainty in the next few years. However, uncovering these bargains will require a lot of due diligence to avoid falling for value traps.
Real estate investors should make sure to heavily scrutinize every opportunity that presents itself. While there will certainly be some opportunities to revitalize properties, not all cheap properties will be worth the long-term price.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
