Even the IMF is Worried About US CRE

The International Monetary Fund, which has been paying close attention to the commercial real estate industry in the U.S. and around the world since the start of the pandemic, is warning that U.S. financial regulators must remain vigilant to prevent further deterioration of the sector in the U.S.

“Rising delinquencies and defaults in the sector could restrict lending and trigger a vicious cycle of tighter funding conditions, falling commercial property prices, and losses for financial intermediaries with adverse spillovers to the rest of the economy,” the IMF stated in a blog post.

The agency is especially concerned about the potential effects on the nation’s financial system.

It noted that about 25% of the estimated $1.2 trillion of CRE debt due to mature in the next two years is held by banks and commercial mortgage-backed securities.

“Financial intermediaries and investors with a significant exposure to CRE face heightened asset quality risks. Smaller and regional U.S. banks are particularly vulnerable as they are almost five times more exposed to the sector than larger banks,” the IMF warned.

Indeed, about two-thirds of U.S. banks have already tightened their lending standards for CRE construction and development loans – “up from less than 5% early last year,” the IMF noted.

It noted that higher borrowing costs impact CRE prices directly by making investments in the sector more expensive. They also have an indirect effect by slowing economic activity and reducing demand for CRE.

The IMF noted that in the past, Fed interest rate hikes generally did not cause CRE price instability or resulted in milder losses, unless they were followed by a recession. The difference this time around, it found, was “the steep pace of monetary policy tightening,” which contributed to the sharp increase in mortgage rates and CMBS spreads.

“It has also notably slowed private equity fundraising – an important source of financing for the sector in recent years,” the report commented.

The Mortgage Bankers Association’s 4Q 2023 CRE loan performance survey backs up the IMF’s concerns. Participants reported on $2.7 trillion of loans in December 2023, representing 58 percent of the total $4.6 trillion in commercial and multifamily mortgage debt outstanding.

The MBA survey shows delinquencies and late payments are continuing to rise. In 4Q 2023, just 96.8% of outstanding loan balances were current or less than 30 days late – down from 97.3% at the end of 3Q 2023 and 97.7% at the end of 2Q 2023. The number of loans more than 90 days delinquent or real estate owned (REO) increased to 2.3%, and the share that were even more behind on payments rose as well.

Office properties were largely responsible, due to a sharp rise in delinquencies and late payments from 5.1% at the end of the third quarter to 6.5% in the fourth quarter. Lodging also fell behind, with delinquencies up from 4.9% to 6.1%. Retail delinquencies remained largely flat at 5%, but the share of delinquent multifamily and industrial loans rose from 0.9% to 1.2% and 0.6% to 0.9% respectively.

CMBS loans were the worst affected; delinquencies rose from 4.4% to 5.1% in 4Q 2023. There were also increases in delinquent FHA multifamily and health care loans, life company loans and GSE loan balances.

“Each loan and property faces a different set of circumstances, which will come into play as the market works through loans that mature this year,” said Jamie Woodwell, MBA’s head of CRE research.

Meanwhile, it remains to financial supervisors to implement the IMF’s main recommendation: “Ongoing monitoring and management of risks related to the sector will be important to mitigate potential risks to macro-financial stability.”