These are the CRE Loans Most at Risk
There is some distress out there, but a “massive wave” of systemic bank failure remains unlikely.
Even with subtle news developments about commercial real estate distress, Marcus & Millichap stands by its earlier call that a systemic bank fallout from commercial real estate is unlikely, while there are some sectors that are riskier than others.
John Chang, senior vice president of research services, Marcus & Millichap, said in a recent company-produced video that loans created with aggressive underwriting and financing strategies and those that used floating debt without a hedge are most susceptible.
Loans with 80% leverage and probably a few other high-risk decisions are at greater risk because most CRE loans use 65% LTV.
Floating rate debt without a rate cap or hedge is another potentially risky proposition. ADR mortgages not long ago were made in the mid-3% range, but now that rate is 6% to 8% in some cases and higher interest rates have hurt cash flow.
“Loans such as these aren’t the norm, but are the exception,” Chang said. “Banks generally have more stringent policies in place, and most wouldn’t make these aggressive loans.”
Chang said the office sector, particularly in the urban core, needs to be watched, not necessarily because of a risky loan, but due to post-pandemic behavioral changes when it comes to being in the office.
The hybrid work model is now the norm. Most companies experience less than 50% of office utilization, whether it’s that the office is less than half full, or workers go to the office less than half of the time.
In analyzing markets, Austin has the highest office utilization, and the Bay Area has the least. Companies might shrink their footprints when leases come due, and that could spark a wave of risk that landlords would have to deal with, according to Chang. Office vacancies could reach 25% to 40%.
The CRE local urban core ecosystem is also experiencing some risk creep, as the lack of downtown workers is affecting other sectors such as retail, restaurants, entertainment, and tourism, creating a snowball effect.
There is some distress out there, but a “massive wave” of systemic bank failure remains unlikely, but there will be some choppy waters in the near term and investors will need to remain vigilant.