Lenders Turn Up the Foreclosure Heat on CRE

Many analyst takes on commercial real estate markets have been in terms of where loans stood. This includes CMBS, banks and what have you – but the question has been percentages of delinquencies or properties in special servicing.

There’s been an assumption that banks in particular have been indulging in the practice colloquially called “extend and pretend.” In April, Autonomous Research estimated that 40% of bank CRE loans maturing this year actually being holdovers from 2023 and that banks on average are reserving 8% of their CRE portfolios, which is about five times more than normal. PGIM Real Estate that expected bank CRE maturities was up 35% from previous estimates.

But where the concrete meets the pavement, if you will, is when lenders take back properties, whether because borrowers have walked away, or the hammer has come down in a foreclosure. That’s on the rise, according to a Wall Street Journal report.

Portfolios of foreclosed and seized properties reached $20.5 billion, according to data from MSCI. That’s a 13% quarter-over-quarter jump and the highest figure since 2015.

Back to extend and pretend. No lender wants to take the keys back. They don’t have the expertise in profitably running a building nor the desire. Legally holding the property means that the value hits the balance sheet in an uncomplimentary way and investors start asking what is going on.

However, delay tactics last only so long because auditors will eventually say the time has come to admit defeat. Then investors can see what is happening and they start asking pointed questions.

A Journal graph of the MSCI data shows the total of seized properties over time. The current $20.5 billion isn’t at the heights of the Global Financial Crisis when it was more than double. But the trend line is on an upswing, suggesting a good chance that things could get considerably worse, especially in offices, where only 15% are in the Class-A category, which has maintained values higher values and lower vacancies. The remaining 85% are in potentially big trouble because there is decreasing evidence that they can be saved by would-be tenants.

Higher rates of foreclosures have, in the past, signaled the end of a crisis and the arrival of a bottom. Lenders who take back properties usually want it off their books quickly. That can aid price discovery, as the Journal notes, and help the market start to work again.

Currently, the economy is looking relatively strong, with a first Fed rate cut possibly in the offing in September. Should there be a slide, however, CRE markets could get far worse.