Property Type and Vintage Matter Most in Assessing CRE Loan Risks

There has been an unfortunate inclination to look at commercial real estate and lenders in a homogenous blend since the beginning of the downturn in 2022. That isn’t the case, said MSCI in a report called, “The What and the When Matter for the Losses of Real-Estate Lenders.” When estimating losses — and not all will face them — types of properties and loan origination timing are the key factors.

“There is a timeline of the market cycle, how prices have evolved,” Jim Costello, executive director of MSCI Research, told GlobeSt.com. “If you did a 10-year loan and originated a loan in 2015 for an apartment building, you had so much price growth along the way, you’re probably going to be able to refinance.”

If borrowers started in 2022 with short-term loans that were fashionable at the time — a three-year loan, maybe, and 80% loan-to-value on an apartment in the Southeast — “there’s a low chance of getting refinancing” when it comes time for the borrower to get it.

“The narrative that everything is falling apart, part of that comes from how people make decisions,” Costello says. “We have a bias of looking backward to what we know. We make decisions based on experiences. That’s how humans learn. We see falling prices, we see a few lenders in trouble. How do I make sense of it? I look at previous events.”

The previous events will depend on a person’s experiences. There are different “bad memories in the CRE industry,” the report said. It might be the savings-and-loan crisis of the 1980s, with a sharp drop in prices and bank failures. Or it could be the 2008 global financial crisis, with worldwide liquidity collapse and a wide price collapse not only of residential and CRE properties but of equities and many synthetic bonds that investment banks had created.

Starting with experience is a natural first step. “But I think you need to go deeper,” Costello added. “Don’t use the last downturn as the playbook.” Because inevitably conditions, problems, and solutions are different.

MSCI looked at 6,400 lenders and marked the underlying pool of collateral to market value in the second quarter of 2024 by either increasing or decreasing the value at origination with the most relevant hedonic price index.

The current downturn differs from previous ones like the global financial crisis. Capital isn’t concentrated as it was in the past but is more diverse in nature.

Costello says that factor helps explain why the expectations of a giant distress market haven’t come to fruition the way many investors and speculators thought it would.

“The capital is a much more diverse tool,” he said. “You didn’t see the increase in distressed sales because you didn’t see a big increase in the forced defaults. All the people hoping and wishing and praying you’d have distress? It wasn’t there.”

Fundamental stress remains, with many obsolete office buildings, retail units, and hotels. Timing has been everything overall. Industrial properties largely have unrealized gains. However, price declines have generated unrealized losses in office, including loans that originated well before the pandemic. Apartment loans from before 2021 Q3 show unrealized gains, versus originations after then largely show unrealized losses.

“When we see the distressed assets, the people buying these fundamentally distressed assets, it’s local owners operators,” said Costello. “They know how to swing a hammer and who know the local [officials]. A financial guru who sees it as a line of numbers in an ARGUS Run won’t be able to make it.”