Rate cuts cannot fix the structural issues crushing office & retail CRE. But industrial, fueled by ecommerce, is in good condition.
By Wolf Richter for WOLF STREET.
Maybe Commercial Real Estate has hit “bottom” – as property giant Blackstone’s president and chief operating officer, Jonathan Gray said in January during an earnings call, which then was echoed by other CRE fund managers with lots of troubles in their portfolios. Or maybe it hasn’t.
Parts of it are in deep trouble, such as office, retail, and lodging, including for structural reasons that have nothing to do with interest rates and cannot be cured with rate cuts. Multifamily is not in as bad a shape, though problems abound amid numerous defaults and oversupply in some markets (oversupply of housing is exactly what consumers need, so this is a good thing for the economy but not for lenders and investors). And industrial, such as warehouses and fulfillment centers, is in good shape, though the bloom has come off the rose too.
Office CMBS.
Delinquency rates of office mortgages backing commercial mortgage-backed securities (CMBS) spiked to 8.4% in September, the highest since the peak years of the Great Recession from August 2011 through November 2013, according to data by Trepp today, which tracks and analyzes CMBS.
The delinquency rate has now surpassed the spike that followed the American Oil Bust from 2014 through 2016, when hundreds of companies in the US oil and gas sector filed for bankruptcy, which devastated the Houston office market in 2016.
The office sector of CRE faces a structural problem: A huge office glut after years of overbuilding amid massive hype about the “office shortage” that led big companies to hog office space as soon as it came on the market with the hope they’d grow into it. Now companies realize that they don’t need all this office space, and vast portions of it sits there vacant and for lease. Rate cuts will do nothing to address these structural issues, though they might help some borrowers refinance a maturing loan on a building with adequate occupancy.
Mortgages are considered delinquent by Trepp when the borrower fails to make the interest payment after the 30-day grace period. A mortgage is not included here if the borrower continues to make the interest payment but fails to pay off the mortgage when it matures. This kind of repayment default, while the borrower is current on interest, would be on top of the delinquency rate here.
Loans are pulled off the delinquency list if the interest gets paid, or if the loan is resolved through a foreclosure sale, generally involving big losses for the CMBS holders, or if a deal gets worked out between landlord and the special servicer that represents the CMBS holders, such as the mortgage being restructured or modified and extended.
Retail CMBS.
The delinquency rate for mortgages backed by mall properties spiked to 7.1% in September.
Mall properties and other retail properties have been in trouble for years, as ecommerce is taking their business away, a phenomenon that we’ve called the Brick-and-Mortar Meltdown since 2016. And even the big mall landlords have all been defaulting on mall loans and letting the affected property go back to lenders.
For example, Simon Property Group [SPG], the largest mall landlord in the US, has trimmed its mall count for over a decade, including by defaulting on mall loans and walking away from several properties. In June, it began walking away from another mall, the second largest mall in Pennsylvania, the 1.7 million square-foot Philadelphia Mills outlet mall. The loan came due, and SPG failed to pay it off. In July, it emerged that it was negotiating with the special servicer to hand the property back to the CMBS holders.
Countless retail chains, from Sears on down, filed for bankruptcy, and many were liquidated. Zombie malls sit abandoned until a developer can bulldoze the buildings and build housing on the property.
This is the structural problem of brick-and-mortar malls, as Americans have changed their shopping patterns with a relentless shift to ecommerce. Department stores have been totally crushed, with only a handful of survivors that have all slashed their store counts of the years.
No rate cut ever is going to stop ecommerce from continuing to take over a big part of the retail business.
Exempt from the meltdown have been strip malls anchored by grocery stores, and service establishments and restaurants among the other tenants.
Lodging CMBS.
The delinquency rate for mortgages backed by hotel and resort properties rose to 6.2% in September, after declines in the prior two months.
During the pandemic, when many hotels were shut down for a while, the delinquency rate had spiked to 24% in June 2020. During the Great Recession, it topped out at 19% in September 2010.
The structural problem in lodging is that many American and foreign tourists choose to spend the night at vacation rentals rather than hotels. In touristy cities, vacation rentals are everywhere and have taken a substantial part of the lodging business in those cities, often bypassing the hotel taxes, and hotels ended up with high vacancy rates. The nefarious effect in those touristy cities is that a portion of the housing stock was very quickly converted into lodging, which distorted the housing market even more.
Multifamily CMBS.
The delinquency rate of CMBS backed by mortgages for multifamily buildings was roughly unchanged in September, at 3.3%. During the Great Recession and Housing Bust it topped out at nearly 17% in early 2011.
There have been a number of big mortgages that defaulted over the past two years, but CMBS reflect only a tiny portion of the multifamily mortgages.
The US government is on the hook for over half ($1.1 trillion) of mortgages backed by multifamily buildings. The remainder is spread across private-sector lenders, including banks and insurance companies. Private-sector CMBS, CDOs (collateralized debt obligations), and ABS (asset backed securities) combined hold only 3.2%, or just $67 billion, of the multifamily mortgages. CMBS alone represent an even smaller portion.
The small universe of multifamily CMBS is why each major delinquency moves the needle up a lot, and each major resolution moves it down a lot. This occurred in January 2016 when a $3-billion delinquent loan was resolved when Blackstone and Ivanhoe Cambridge bought the Stuyvesant Town–Peter Cooper Village residential development in Manhattan (11,250 apartments in 110 buildings) and paid off the delinquent loan, leaving that big vertical line in the chart:
Industrial CMBS.
The delinquencies for mortgages backed by industrial buildings – warehouses, fulfillment centers, etc. – dipped to 0.3% in September, which is historically low. During the Great Recession, the delinquency rate topped out at over 12% from late 2011 to mid-2012.
This industrial sector reflects the counterpart of ecommerce; it’s the brick-and-mortar part of ecommerce. All major ecommerce retailers and third-party platforms – Amazon, Walmart, Macy’s, Target, Home Depot, Best Buy, Costco, Kroger, and many others, and specialized retailers such as Wayfair, etc. – have set up ecommerce fulfillment operations across the US.
During the pandemic, there was a massive boom in fulfillment centers which brought on a lot of supply. That boom has now faded, leaving the sector with some oversupply and rising but still relatively low vacancy rates – 6.1% in Q2, below the 10-year prepandemic average of 7%, according to Cushman & Wakefield. Asking rents, after spiking 50% from Q1 2020 through Q2 2023, haven’t moved much since Q2 2023. But ecommerce is stronger than ever, and there’s no structural collapse of demand as there’s in the office sector.
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So much for CRE shills claim that “we bottomed.”
Thanks for this article.
Keep your CRE off of me.
Much sad news, buildings sitting empty. Reminded me of my mother, every year she would “can” peaches and cherries. Now all the mason jars sit empty in the cellar covered in dust.
No big deal, tear down the stupid buildings and build another stupid building…a few weeks and done…..refreshments anyone?
It looks like it is turning into not a big deal? I am amazed a bank can sometimes hold a vacant property for a long time.
I remember during the HB1 that there were 3 strip malls built near me and finished in 2008 in areas where new subdivisions lots were being built but went bankrupt.
Those housing lots and those those strip malls sat empty for 7 to 8 years. The housing lots were sold in an auction but a For Sale sign never was placed on the strip malls. After about 8 years somebody bought the housing lots and started building homes again. The lots are now full of houses and slowly the strip malls started to fill up from 2018 to now.
Anyway, the strip mall sat empty for almost 10 years and they were kept up and looked brand new year after year. I always wondered who could build a strip mall, provide maintenance and power (little because they were empty) and wait 10 years before getting any revenue.
I wonder what happens with utilities in that scenario.
If they don’t keep the heat (gas) going, pipes will freeze in the winter. Electric would need to be maintained too. Who’s paying those utility bills?
To most everyday joe, this CRE mess is a nothing burger for them since it is effecting residential market or their employment status, disposable incomes..etc.
The big question is if or at what point does it become something even normies would care about, especially if it looks like it won’t simply disappear with easing of interest rate or minor QE here and there…
My local mall is a ghost town. Maybe 50% vacant, with a few tenants moving to smaller footprints but I asked one if they’re getting a break on rent by doing so and they said NO! Macy’s is gone, but the Ross still has customers. GNC just closed down, not sure how they lasted this long as I never saw customers in it ever. Popular sushi place also closed down, always had a line so that was surprising.
All these stores and restaurants closing represents loss of jobs and income but we are told by Krugman and other scum that its the best economy ever.
Related: Below an online ad from a well known lender. Name of same omitted.
‘Need Cash for the Holidays? How to Unlock your Home’s Equity.
Experts Urge Americans To Access Home Equity Before It’s Too Late
Turn Your Rising Home Equity Into Cash You Can Use
Want Cash Out of Your Home? Here Are Your Best Options
Your home value could go down anytime. Borrow now while it’s high!
To which they could add: ‘Visit a fulfilment center soon! ‘
But I guess that’s the warehouse.
“Before It’s Too Late”
@ChrisFromGA if Blackstone really believed CRE has “bottomed” in January they would not have sold the NYC property at 1740 Broadway for $185 million (a $420 million loss) this past March (and they would be buying).
With rarre exceptions I think most real estate in the US is still overpriced with most office and retail WAY overpriced with the percentage of people working from home and shopping from home still increasing every year.
@Phoenix_Ikki I agree with you that “To most everyday joe, this CRE mess is a nothing burger for them” When I was in High School Chrysler was still making two ton land barges that got 9mpg and before the (first) bailout things were tough for people in the auto industry but like the CRE problems today the auto industry problems didn’t the everyday joe (or everyday apartment owner) in 1980 or in 2008 whe both Chrysler and GM gotbailed out.
“most real estate in the US is still overpriced”
This.
Amen to this and sadly, still doesn’t seem to scare off some FOMO buyers or diehard believers in certain part of the country, reduce demand sure but still plenty of suckers are willing to pay over $1M for a crapshack in many parts of SoCal
Everyone “buying” a $1mm crapshack is not a “sucker” If you want to make big changes to a home (like putting a second garage door in the back of your garage to park your race car trailer in the back yard) It makes sense for some people to go from paying a landlord $5K/month to “rent a home” to paying a bank ~$5K/month to “rent $1mm” so you can “buy” a crapshack (and not need to ask anyone before you replace the electric stove with a gas one or move the walls around…
Thank you for that informative report.
1) The stevedores strike disrupt interstate commerce. That’s against the law. Transport and warehouse will slow down.
2) Precision AI and GPS can unload containers from a ship, load on a self driving truck, unload in a port parking lot, before unloading on a train or a truck.
3) Stevedores making $250K/$500K per year plus a cash envelopes to prevent an Italian strike, or dropping container by accident, will fight tooth and nails to preserve decades of extra privileges.
4) Port strike, Helene death toll, higher oil, Long beach clogging, consumers anticipating shortages, the never ending ME might start
a new wave of layoffs, prepared already by HR. BLS might discover more new immigrant in the labor force. That will overpower layoffs and lower hours of work.
Many years ago, I was buying shares of Macy’s. The thesis: shares were trading below book value bc Macy’s RE holdings were worth a lot more than what the market was pricing.
Glad I no longer hold that position.
It’s all got to hit the fan at some point. Stocks, real estate, the EVERYTHING BUBBLE. S&P 500 market cap almost $57 TRILLION, and of course, three companies supposedly worth $10 TRILLION. Yeah, right. Nvidia is worth three Berkshire Hathaways. Yeah, right.
Standing firm that the S&P is a LOCK to see 4500 again, and 4000 is a coin toss. One down month since last October. No government intervention to keep stocks pumped up before the election. Yeah, right.
So where does all that wealth flow? Gold, silver, cash, buying small countries? Clearly there will be a move out of the market at some point and those first out will likely cash out, wait until they think it is close to bottom, and then jump in and then ride it back up. Unless taxes significantly go up to fund the deficit then wealth will keep accumulating and of course if taxes go up that will likely drive more spending.
I am making the assumption wealth will continue to grow and not be spent among those that own much of the wealth.
It’s hard to imagine lodging having trouble in southern California, room rates have gone through the roof since Covid.
yes, we’ve seen that too, but you can get rooms — that’s part of the problem, they jacked up rates too much and now they can’t fill their rooms.