Distress Jumps While Extend-and-Pretend Continues

CRED iQ’s CRE distress rate calculation took a jump in April to 8.35%, an all-time high in their measure. That was a month-over-month 74-basis point increase from 7.61% in March. And that one was a record.

The firm said that the “distress rate was significantly affected by one large loan which impacted the segment distress rate in a fairly dramatic fashion.” A reasonable point, but still, it meant that things were already in a state in which there was enough of a base to make the new record possible.

Multifamily was the big driver, going from 3.7% in March to 7.2% in April on its own. That was due to “a $1.75 billion loan ($561,000/unit) backed by Parkmerced, a 3,221-unit multifamily property in San Francisco,” they wrote. That was a 152-acre parcel with townhouse and tower apartments. In 2019, students were 17% of the occupants, suggesting that school closures during the pandemic could have had a cumulative effect. “Imminent non-monetary default caused the loan to transfer to the special servicer with the looming maturity date of December 2024. Furthermore, the assets have been underperforming with a below break-even DSCR of 0.47 and 83.5% occupancy.”

The number two position was retail, moving from 9.5% to 11.9%, a record level for the segment. Hotel went from 7.7% to 8.7% for the third position. Interestingly, the next one was office, seeing only a 3-basis-point increase.

Industrial and self-storage distress rates were below 1%.

“Nearly one third of loans of the distressed loans are current or within the grace period,” they wrote. “The largest category was non-performing, matured at 36.8%. The closely watched performing matured category represents 9.2% of the loans.”

The next big question, though, is what will happen with coming loan maturities. “Although more defaults are likely, we expect that a significant amount of commercial real estate loan maturities this year will be extended to 2025 and beyond,” wrote CBRE in a recent report. They said that the defaults will be concentrated in office (high vacancy and lower demand) and multifamily (too many deals done at “ultra-low interest rates” with high leverage that makes refinancing at higher interest rates difficult).

Bank lending will continue to be “subdued,” as many of the heavy CRE lenders have been trying to reduce their exposure and potential hit to asset values. Otherwise, they face risk of large withdrawals of deposits by concerned customers — as happened to Silicon Valley Bank, Signature Bank, and First Republic Bank last year — and eventual forced shutdown over regulator concerns about solvency.

Of the $4.7 trillion in CRE loans outstanding, almost $2 trillion mature in the next three years. “CBRE expects that most of these loans will be extended, although some forced sales will occur as lenders lose patience or borrowers default,” they wrote. There are $900 million in loans maturing this year, with multifamily responsible for $257 billion and office, $206 billion. Then out of the $700 billion that came due last year, $271 billion were extended into this year.

All this leaves the big question of how long lenders can continue the so-called extend-and-pretend strategy. The calculus has been that interest rates would come down and make refinancing possible, but how many cuts, and their total, the Federal Reserve might provide is unknown. Three for 75 basis points seem to have become two and 50 basis points at the most, and maybe not that.