US Commercial Real Estate: A Brewing Storm of Delinquencies and Distress

The US commercial real estate (CRE) sector is facing escalating challenges, marked by a significant increase in delinquencies and rising distress levels. At the end of March, distress in CRE surged by 23% year over year, reaching over $116 billion, the highest in more than a decade. This concerning trend follows a period of surging borrowing costs and the widespread adoption of remote work, which have left lenders vulnerable to substantial losses.

While the rate of increase in delinquencies has moderated slightly, the overall volume continues to climb. The pain is particularly acute in the office segment, with warnings from investors about a potential "tsunami" of problems stemming from upcoming debt maturities. There are also indications that this distress is spreading, with the past-due and nonaccrual rate for CRE portfolios reaching its highest point since 2014 earlier this year, and multifamily properties increasingly contributing to the issue. Past-due and nonaccrual loans are those so far in arrears that banks have ceased accruing interest, doubting repayment.

Policy uncertainty is also hindering activity in the underlying CRE market, as businesses delay crucial decisions across various districts. For instance, some financial institutions have noted that demand for warehouses has been impacted by the potential implications of tariffs.

Adding to the complexity, a proposed "revenge tax" could trigger a wider pullback from foreign investors, affecting all US real estate lenders. One European commercial property lender recently announced its exit from the US market, winding down its significant portfolio and anticipating potential losses this year due to the decision. However, this exit's timing may suggest a belief that current market conditions offer a favourable window for divestment amid improved liquidity and competition in the debt market.

This improved liquidity is partly due to direct lenders raising more capital for CRE investments, a trend that is simultaneously raising some concerns. A global financial stability body recently cautioned that "shadow lending" to the industry globally "may amplify and transmit shocks to banks".

Meanwhile, some traditional lenders in the US are opting to "kick the can down the road" by extending loan durations rather than recording impairments. This practice contributes to the growing wall of CRE debt. Traditional lenders are also grappling with substantial unrealised losses on their securities portfolios, amounting to over $410 billion. Experts suggest that unrealised losses on banks' mortgage books, including both commercial and residential, are likely to be as large as, or even exceed, those on securities portfolios.

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