This Analyst Says a CRE-Driven Financial Meltdown Is Unlikely

It is possible commercial real estate could negatively impact the banking sector and the financial markets, but that’s not really the most likely scenario.

“At this point, we’re not seeing that level of risk,” according to John Chang, Senior Vice President and National Director of Research and Advisory Service, Marcus & Millichap.

Speaking this week on his firm’s analyst video, Chang said, “And in all honesty, we’re already, hopefully, on the backside of the risk cycle.”

Chang described CMBS loan delinquency rates for all major CRE asset classes, comparing them to key time periods in the past 20 years or so.

“Although CMBS loans are not fully representative of all the lenders out there and yes, it’s possible there are banks with disproportionate amounts of risk, we just haven’t seen that much delinquency or distress in the commercial real estate market,” Chang said.

“Additionally, the FDIC and the Fed have provided guidelines enabling banks to work with their clients to extend loans or to create some other alternative to address maturing debt and reduce the risk to the banking sector.”

Chang said that given the fact that the economy is outperforming expectations and inflation has come down significantly, it’s widely believed that the Federal Reserve will begin to reduce rates this year, further backstopping the strength.

“So while a commercial real estate driven financial catastrophe is possible, the evidence just isn’t showing up in the property fundamentals and it’s not showing up in the mortgage delinquency rates,” according to Chang.

Marcus & Millichap said CMBS delinquency rates are generally low compared to prior crises.

Delinquent means that a payment is 30 or more days late, Chang said, and being 30 days late on a payment is a far cry from foreclosure.

The current CMBS delinquency rate for apartments is 2.6%. To put that in perspective, the average delinquency rate between 2016 and 2019 was just 2.4%, and that was when apartment performance was looking quite good, Chang said.

Multifamily delinquencies peaked in the pandemic era at just 4.5% and during the global financial crisis, delinquencies peaked at 16.9%.

The media is beating the negativity drum, Chang said, citing a recent article saying retail was facing a crisis.

Retail vacancy rates, however, are at or near a 20-year record low, while rent growth is on the upswing, according to Marcus & Millichap.

The current CMBS delinquency rate for retail is 6.3%, which is higher than multifamily, but retail generally has a higher delinquency rate than the multifamily sector.

The average delinquency rate for retail between 2016 and 2019 was 4.1%. Retail delinquencies peaked during the pandemic, basically when all the retail centers in the entire country were closed at 18.4%.

For hotels and lodging, hotel occupancy rates are almost back to pre-pandemic levels, but the average daily rate for hotels is up significantly, Chang said.

Full-service hotel nightly rates are 24% higher than before the pandemic while limited-service rates are 20% higher than before the pandemic. The current lodging CMBS delinquency rate is 5.5% compared to the 2016 to 2019 average of 2.7%.

“But they’re dramatically lower than the peak during the pandemic when 24.3% of lodging loans were in delinquency,” Chang said. “Or the 19.5% lodging loan delinquency rate during the financial crisis.”

Office has been hit hard vacancy rates are at a record high while rents have been flat, at best.

So, surely office will demonstrate a real estate crisis, Chang said rhetorically. The current CMBS office loan delinquency rate is 6.3%, and the average between 2016 and 2019 was 5.1%. The average CMBS office loan delinquency rate in 2017 was 7.2%, higher than it is now. During the financial crisis, the office delinquency rate peaked at 10.7%.

The current CMBS delinquency rate for industrial is 0.4%, so that’s not newsworthy, Chang said.