CRE Credit Trends to Deteriorate Through 2025

Credit trends in commercial real estate will continue to deteriorate through 2024 and into 2025, says Fitch Ratings. Office will lead the decline, but properties in other sectors — retail, hotel, multifamily, and industrial — will also face deterioration the credit rating agency said.

“For U.S. CMBS, we expect the greatest decline in property net cash flows from office and non-trophy malls as growing macroeconomic headwinds and high interest rates lead to increased maturity defaults,” they said. “Fitch forecasts overall U.S. CMBS loan delinquencies to double from 2.25% in November 2023 to 4.5% in 2024 and 4.9% in 2025.”

According to the agency, November U.S. CMBS office delinquency rose by 64 basis points in November to 3.48%, with $1.59 billion in new 60-plus day loan delinquency. That was the largest increase since June 2020. The majority was office and multifamily.

“Fitch forecasts U.S. CMBS office loan delinquencies to jump to 8.1% in 2024 and 9.9% in 2025 and for U.S. CMBS multifamily loan delinquencies to increase from 0.62% in November 2023 to 1.3% in 2024 and 1.5% in 2025,” they said.

Office, in particular, will see a continued split. In larger central business districts, particularly among vintage properties, office CRE is and will be “highly vulnerable” because of the shift to hybrid work. The move has driven down valuations that, in turn, makes refinancing more difficult. The problems become more acute with “tenant rollover and/or lower debt service coverage ratios.” Fitch expects that through 2024, office properties on the whole will see falling net operating income growth, particularly for lower-quality urban office properties.

Some of the office transaction price drops have been notable. In New York, price per square foot dropped from over $600 per square foot to under $400 year-to-date in 2023. The biggest shock has been San Francisco — well over $1,000 in 2020 to maybe $350 now.

National average office vacancy rates are 13.5%; at the end of 2019, they were 9.5%. Adding lower tenant office needs and additional sublease vacancies and the total availability rate is at al all-time high of 16.6%.

“We expect the national office vacancy rate to increase to 15.7% by YE24 [year end 2024] and 16.6% by YE25, and current market rents to decline 3.3% by YE24 and an additional 2.2% by YE25,” they wrote.

In Fitch’s estimation, U.S. life insurance company exposure to CRE is “largely comprised of diversified, high quality investment portfolios, with conservative underwriting, strong liquidity and effective asset-liability management.” The investment is mostly in commercial mortgages, with low exposure to CMBS.