DC Replaces San Francisco With the Highest Share of Office Properties at Default Risk

As Trepp recently estimated, new CRE loan originations in Q3 were $2.5 billion, down from $4.7 billion in Q2. Multifamily (from $2.2 billion to $1.1 billion between quarters) and lodging ($0.2 billion down to $0.1 billion) saw the biggest quarter-over-quarter decreases.

But that was only part of the story. The report also covered a “surge in both short-term and serious delinquencies” as well as defaults. “CRE mortgage delinquencies experienced another uptick, continuing the upward trend that started in Q4 2022. However, in Q3 2023, the slope of the increase steepened, with the total delinquency rising to 1.5% in Q3 2023 from 1.2% in Q2. The serious delinquency rate, or the non-current loan rate, experienced an increase to 1.3% in Q3 from 1.0% in Q2.”

Concerns about delinquencies and defaults in commercial real estate come from at least three directions. One is from regulators concerned about bank stability. There are $6 trillion in loans as of 2023 Q2, with half sitting on the balance sheets of banks, because these don’t get sold off to government agencies the way residential mortgages do. CRE loans are also the largest loan category for almost a half of all U.S. banks.

Another is from the banks themselves and borrowers. No one in CRE wants to get trapped with an inability to refinance a property and the need for too large an equity investment to keep things going. And banks don’t want keys to the property backing a failed loan.

A third is from the industry at large. Properties that end up in fiscal and legal trouble have an effect on perceived values, potentially driving them down.

The office sector provides an excellent example. “On a dollar-amount basis, bank write-downs for office loans have continued to surge in the third quarter,” they wrote. “In the previous two quarters, the net charge-off amount for the office sector more-than-tripled consecutively to $149 million in Q1 2023 to $459 million in Q2 2023 from $49 million in Q4 2022. In Q3 2023, the office net charge-off amount rose to $589 million.”

But your eye has to stay on the topic to be sure you know where thing have gone. For example, the lodging delinquency rate used to be higher than that of office. The two switched in Q3. Or, as they wrote about what they call criticized loans — an analysis they do to rate loans in a projected likelihood of default: “Trepp recently released a three-part series on bank CRE risk assessments, which provides deeper dives into specific property types and across geography. A notable change that occurred in the updated Q3 2023 bank loan data is that Washington D.C. has replaced San Francisco as the MSA with the highest proportion of office criticized loans, where Washington D.C. now has a 72.0% criticized share, whereas San Francisco has a 71.0% criticized share.”

Even as there is pressure on CRE, the data and deductions professionals can make for it are constantly changing.