frequently asked questions

Frequently Asked Questions

How has the Current Banking Environment Affected Commercial Real Estate?

Currently, distress levels in the commercial real estate market are relatively low. The failures of Signature Bank and Silicon Valley Bank raised concerns about the potential failure of other regional and local banks due to their significant exposure to commercial real estate loans. However, apart from certain market sectors, most commercial mortgage portfolios have performed well. Typically, during periods of market uncertainty, distress levels in commercial real estate tend to rise significantly. However, the current distress levels are low compared to historical standards. By the end of 2022, distressed commercial real estate assets accounted for only 1.2% of the total national sales volume. This figure is crucial to monitor as many loans face maturity and higher interest rates upon refinancing in 2023.

Estimates from MSCI, Inc. suggest that approximately $400 billion worth of loans will mature in 2023, while the Mortgage Bankers Association projects the amount to be over $700 billion. Many analysts predict an increase in loan defaults for two reasons: firstly, many of these maturing loans will require refinancing at higher rates, potentially leading to cash flow issues; and secondly, there are fewer active lenders in the market due to recent bank failures. Loan underwriting has become more stringent due to global financial conditions, resulting in a decline in the average loan-to-value ratio for new originations.

While certain properties have kept up with market trends thanks to rising rents and strong appreciation, others, particularly in the office and retail sectors, have struggled due to higher vacancy rates and fixed long-term rental rates. The multifamily and industrial markets, which account for approximately 35% of the 2023 maturities, have experienced strong operating income growth. On the other hand, the office market has witnessed stagnant revenue growth over the past five years, accompanied by an increase in vacancy rates. This sector, representing around 26% of the 2023 maturities, is expected to experience a significant rise in distress and defaults, as many properties will not generate enough income to pay off existing loan balances.

In February 2023, Trepp Inc., a data analytics company, reported a rise in commercial mortgage-backed securities loans (CMBS loans) entering special servicing, estimating the percentage at 5.2%. Properties such as office buildings and retail centers, included in these CMBS loans, may be subject to distressed sales. Additionally, borrowers with adjustable-rate loans may face distress unless they have hedged their risk with interest rate caps. These borrowers are now dealing with debt payments that surpass the net operating income of the property, and they are unable to raise rental rates sufficiently to keep up with the increased debt service. Many of these borrowers will likely have to sell their property under distress or invest more capital into the property and refinance for lower loan amounts.

National, regional, and local banks hold more than half of the total amount of commercial real estate loans maturing in 2023. Currently, distress levels have not reached a point where they threaten the financial stability of these institutions. Most lenders are likely to extend the maturity deadlines rather than foreclose, as foreclosure would result in losses. Various methods, including extensions and workouts, are expected to be employed by lenders in the near future.

Most analysts agree that the issues faced by Silicon Valley Bank and Signature Bank are not indicative of other small and local banks with commercial real estate portfolios. The failures of these two large banks were caused by more specific circumstances. Silicon Valley Bank's concentration in the venture capital and technology sectors without sufficient diversification, as well as Signature Bank's narrow focus on the cryptocurrency sector under intense regulatory scrutiny, were significant factors contributing to their failures.

The commercial real estate market is highly diverse, encompassing different sectors, geographic areas, and borrower types. Banks that engage in lending to this market can mitigate risk by diversifying their lending across a wide range of borrowers and limiting exposure to any particular area or property type. Lenders who adopt diversified lending practices and adhere to conservative underwriting guidelines are likely to experience minimal distress or financial losses during the current market cycle.

What impact will the collapse of SVB and Signature Bank have on multifamily loans?

Unless the banking crisis expands and leads to the closure of other banks, we anticipate that the recent closures will have minimal impact on the multifamily sector. The affected banks primarily faced challenges related to business lending in the technology and cryptocurrency sectors. Overall, multifamily lending by banks has remained robust, and we do not foresee significant changes in the near future. However, we have observed a slowdown in lending activity due to rising interest rates resulting from the Federal Reserve's efforts to combat inflation. These rate increases have created cash flow difficulties for many multifamily properties.

What type of commercial property should | consider purchasing in 2023?

The commercial real estate market has experienced a significant slowdown due to concerns over inflation, high interest rates, and the possibility of a recession. Different property types have demonstrated varying levels of performance. Apartment buildings located in desirable neighborhoods have fared well, as owners have been able to raise rents and effectively manage the impact of rising interest rates. However, multifamily properties in smaller or less desirable areas, or areas with increasing unemployment rates, have faced more challenges in implementing rent increases.

In the office sector, lender interest is primarily focused on medical office buildings, while general office properties have underperformed due to the work-from-home policies implemented during the Covid-19 pandemic. It is unlikely that office demand will fully return to pre-pandemic levels, making the office sector particularly challenging to navigate at present.

Within the retail sector, essential service businesses like grocery stores and pharmacies have performed relatively well. However, traditional brick-and-mortar retailers continue to face the repercussions of Covid-19 and intense competition from online retailers. Many malls are grappling with high vacancy rates, leading to the repurposing of some properties for alternative uses.

Conversely, the industrial sector has witnessed strong demand for warehouse and distribution space, driven by the needs of online retailers. Industrial properties located in urban markets and close to transportation hubs have performed exceptionally well. It is anticipated that sales prices for underperforming properties will decline in 2023 as investors gravitate towards better-positioned properties in the market.

In what way will commercial real estate loans be affected by the current banking crisis?

On March 10, 2023, Silicon Valley Bank was taken over by the FDIC and placed into receivership. Shortly thereafter, Signature Bank, based in New York, was also closed. These banks had significant involvement in lending to the technology and cryptocurrency sectors. While their closures raised concerns, other banks are currently being closely monitored. The Federal Reserve's strategy of raising short-term interest rates as a measure to combat inflation has exerted pressure on many banks. This is because banks typically hold a substantial amount of short-term treasury debt, which has decreased in value with the rise in interest rates. As depositors withdraw funds from the bank, banks are compelled to sell this debt at a loss.

Where are commercial rates headed in 2023?

In an effort to address the rapid increase in inflation, the Federal Reserve implemented a series of aggressive interest rate hikes in 2022, raising short-term rates in increments of 75 basis points. At the start of 2022, the yield on the 30-day treasury stood at 0.05%. However, as we approach the end of 2022, the yield has climbed to 3.94%. The Federal Reserve has signaled its intention to continue raising short-term interest rates in 2023, albeit at a slower pace and with smaller increments.

Commercial mortgage rates are typically tied to the yields of 10-year treasury notes. These longer-term notes are more influenced by market forces and are less subject to the direct actions of the Federal Reserve. As of the end of 2022, the 10-year treasury yields range between 3.50% and 3.60%, while commercial mortgage rates hover in the mid to high 5% range. The fact that long-term rates are lower than short-term rates suggests that economists anticipate a potential economic downturn or recession. We will closely monitor these trends throughout 2023.

Where are commercial rates headed in 2023?

In an effort to address the rapid increase in inflation, the Federal Reserve implemented a series of aggressive interest rate hikes in 2022, raising short-term rates in increments of 75 basis points. At the start of 2022, the yield on the 30-day treasury stood at 0.05%. However, as we approach the end of 2022, the yield has climbed to 3.94%. The Federal Reserve has signaled its intention to continue raising short-term interest rates in 2023, albeit at a slower pace and with smaller increments.

Commercial mortgage rates are typically tied to the yields of 10-year treasury notes. These longer-term notes are more influenced by market forces and are less subject to the direct actions of the Federal Reserve. As of the end of 2022, the 10-year treasury yields range between 3.50% and 3.60%, while commercial mortgage rates hover in the mid to high 5% range. The fact that long-term rates are lower than short-term rates suggests that economists anticipate a potential economic downturn or recession. We will closely monitor these trends throughout 2023.