Challenges Loom for U.S. Commercial Real Estate in 2024 Amid a Potential Wave of Defaults
Investors anticipate a challenging year for the U.S. commercial real estate market in 2024, with concerns rising over more landlords surrendering struggling properties as debt obligations mature. The sector is grappling with higher interest rates and fluctuating property values, adding to uncertainties despite recent declines in benchmark borrowing rates.
A crucial factor to monitor is the equity remaining in commercial buildings owned by borrowers. Over recent years, property owners have capitalised on soaring values by refinancing at low debt costs. As property valuations decrease, the associated debt often exceeds the building's current worth. Owners facing this equity gap may be more inclined to relinquish properties.
Regulators have identified the nearly $6 trillion outstanding commercial real estate loan pile, with about half owned by banks, as a top financial system threat in 2024. While loan delinquencies and defaults are still below past crisis peaks, signs of stress emerge as borrowers struggle with maturing debt.
Major landlords, including Blackstone Inc., Brookfield Properties, and Columbia Property Trust, have already experienced defaults or write-downs, contributing to concerns about the broader market.
The commercial mortgage-backed securities (CMBS) market, a key commercial real estate industry indicator, has been a popular financing avenue for large loans and property portfolios. CMBS loans often provide non-recourse options for borrowers, making it easier to walk away in the event of a default.
Cash-out refinancing, prevalent in the years leading up to the 2007–2008 financial crisis, has resurfaced. Over the past two decades, owners withdrew approximately $141.5 billion in cash from U.S. commercial properties financed by CMBS, with a net cash extraction of about $93.5 billion in the past ten years.
As interest rates rise and property values decline, there are growing concerns about the ability of borrowers to navigate maturing debt. An estimated $1.2 trillion of commercial mortgage debt is set to mature through 2025, raising the spectre of an elevated risk of defaults, particularly in the office loan segment.
Despite potential challenges, some see opportunities emerging in distressed assets, creating a credit-picker's market. The slow bleed of properties returning to lenders, regional banks selling assets, and pension plans exiting could pave the way for strategic investments in the real estate market.
Market participants are closely monitoring developments, with the coming year expected to bring further clarity on the resilience and adaptability of the U.S. commercial real estate sector.