Distressed CRE Reaches Ten-Year High

Distress has been the buzzy question making the rounds of commercial real estate for more than a year now. When will it really start? When will the falling prices finally bring in the large mounds of capital that have been waiting on the sidelines?

When will the gift wrapping get shredded? The boxes surrounding presents of cheap properties ripped open? The prices turning into big profits when interest rates eventually fall and values finally climbing back up?

GlobeSt.com has previously reported that a secret round of distress might be behind a lot of CRE market performance. MSCI released its U.S. distress tracker and it’s helping to put some surface on the bare bones of distress.

“The balance of distress in the U.S. commercial real estate market climbed for a fifth consecutive quarter to total $79.7b at the end of September,” they wrote. “This figure, which includes both financially troubled and bank owned assets, has not swelled to such a level since 2013, when the fallout from the Global Financial Crisis was working its way through property markets. Still, the current distress level remains less than half that reached during the height of the GFC.”

The actual outstanding distress through the third quarter of 2023 has reached $79.7 billion, though not evenly distributed by property type. As anyone in the industry might guess, the largest single source of distress right now is office, at about $32.5 billion, or almost 40.8% of the total. Retail is in the number two spot: $21.2 billion, or 26.6% of the total. Then comes hotel, 17.9% of all the distress at about $14.3 billion.

The bottom three categories are apartment/multifamily ($7.5 billion, 9.4%), other that includes sectors like self-storage and manufactured housing ($2.5 billion, 3.1%), and industrial ($1.7 billion, 2.1%).

However, the real concern for investors, developers, and owners should be what might come. “Potential distress is indicative of financial stress that, if not reconciled, has the potential to become full-blown financial trouble,” MSCI wrote. But the biggest danger isn’t office but multifamily, at $65.7 billion, or 30.4% of the $215.7 billion total.

But the possible exposure of office is still enormous, at $50.3 billion or 23.3%. Hotel’s $31.1 billion/14.4% comes next, after which are retail ($30.7 billion, 14.2%), industrial ($26.7 billion, 12.4%), and other ($11.3 billion, 5.2%).

“The composition of ownership for distressed assets shows that one-third of the balance of distress is tied to assets owned by private capital, while another third is associated with institutional investors,” they wrote. “Rather than by value, which skews towards institutional ownership, a look at the ownership composition by the number of assets indicates that private investors own 50% of the assets currently classified as distressed.”