Bidenomics Strikes Again! First Office CRE Was Crashing, Now It Is Multifamily CRE (Return Of “Extend And Pretend”)

Lightning strikes TWICE!

One year after regional banks crashed and burned due to the combination of tumbling debt/treasury prices coupled with cratering commercial real estate loans, fears about the current state of Commercial Real Estate – where most offices still see tenants at best 3 to 4 days a week and are literally burning through rents – appear long forgotten. Is that sensible?

For one answer, we turned to the latest report from Goldman’s REIT/CRE expert Chandhi Luthra who has published a visual assessment of the state of CRE in 2024 in terms of loan maturities, 2023 extensions, and property and lender groups. She also looks at the latest transaction and leasing volumes, and shares several key takeaways.

• There are ~$4.7tn of outstanding commercial/multifamily mortgages outstanding, according to the Mortgage Bankers Association’s 2023 Commercial Real Estate Survey of Loan Maturity Volumes.
• More specifically in 2024, $929bn of CRE mortgages are expected to mature, ~20% of ~$4.7tn total commercial mortgages outstanding. In terms of property type, multifamily and office account for ~27% and ~22% of commercial mortgage maturities in 2024 respectively. In terms of lender type, banks hold ~47% of debt maturing in 2024, followed by CMBS at ~25%.

It is worth noting that 2024 commercial mortgage maturities are pushed up by 2023 extensions. As shown in Exhibit 3, among the CRE loans scheduled to mature in 2023, ~$610bn were refinanced, with ~$300bn pushed into 2024 and the remainder into future years. As a result, the total CRE refinancing volume is expected to be ~$929bn in 2024.

Of course, it does not end there, and since there has been no fundamental improvement, it is certain that extension volumes in 2024 will be high as well. However, as interest rates are expected to come down, demand for refinancing in 2024 may outpace that in 2023 according to the Goldman analyst (rates are still far, far higher than where they were when most of the loans were originated several years ago). At the same time, for loans that have already been extended in the past, it is also likely that future extensions could be harder.

Among the loans backed by office properties overall, ~25% is expected to come due in 2024. In terms of lender type, banks (primarily small, regional banks) hold ~38% of total CRE loan outstanding across all years, followed by the GSEs at 20%.

Looking at different debt metrics, DSCR for commercial real estate (office, industrial and retail combined) tracked at 1.52 in Dec, below the historical average of 1.69; debt yields for commercial real estate have been trending well above the historical average of ~11% in recent quarters, while apartments have held relatively well.

Office CMBS DQs have risen significantly, with Jan tracking at 6.3%, up significantly from 1.58% in Dec 2022. And while everyone knows the Office canary in the coalmine is dead and buried, keep an eye on Multifamily CMBS DQs which tracked at 1.91% vs 2.62% in December, with the sequential decline associated with a large San Francisco apartment loan that was recently disposed. The overall DQ rate tracked at 4.66% in January.

The Goldman strategist concludes with a word about CRE transaction and leasing: U.S. CRE transaction market continues to be muted, primarily driven by elevated interest rates, limited sources of capital, and the pricing gap between buyers and sellers. January volume was down -11% yoy, driven by easier compares in Jan 2023 (down -55%). In terms of leasing, Jan preliminary trends indicate weakness in activities, with office down -25% yoy and industrial down -28% yoy.

Here, Goldman trader Sara Cha chimes in (her report is also available to pro subs) and notes that we can see from the transaction data  “why sentiment in CRE brokers is a bit more mixed of late – thought yesterday’s JLL print had mixed reception – while you’ve seen some signs of life in capital markets space broadly to start the year, not seeing that as much on the CRE front (remember those 3Q-4Q greenshoots?).“

Multifamily CRE

The commercial real estate sector continues to experience elevated stress . The latest crack to emerge is the increasing number of delinquencies on multifamily mortgages. 

In April, about 8.6% of commercial real estate loans bundled into collateralized loan obligations were distressed, reaching the record high set in January, according to Bloomberg, citing new data from analytics firm CRED iQ. 

The loans bundled into CRE CLOs were merged with funds from individual investors to acquire multifamily housing during the Covid era. After that, borrowing rates surged, catching many off guard. A significant portion of the deteriorating loans had floating-rate interest rates, putting massive pressure on landlords’ cash flows, diminishing the market worth of the properties, and obliterating equity in a large number of investments. 

According to data provider Trepp, $78.5 billion of CRE CLO loans are outstanding. This means many CRE CLO issuers are racing to find ways to prevent a tsunami of bad loans from defaulting or risk losing the fees they collect on the securities. 

Recent estimates from JPMorgan show lenders purchased $520 million of delinquent loans in the first quarter of this year. Lenders have been ramping up the number of buyouts over the last four quarters because of mounting bad loans in a period of elevated rates. 

JPMorgan strategist Chong Sin said he’s surprised by lenders’ ability to obtain warehouse lines to purchase bad debt, given tightening credit conditions. 

“The reason these managers are engaged in buyouts is to limit delinquencies,” Sin said, adding, “The wild card here is, how long will financing costs remain low enough for them to do that?”

Anuj Jain, an analyst at Barclays Plc, expects buyouts to continue as distress increases across the CRE CLO space.  

“If the outlook for the Fed shifts materially to hikes or no rate cuts for a while, that might lead to a sharp increase in delinquencies, which can stifle issuers’ ability to buy out loans,” Jain said. 

Bloomberg explains much of the CLO space derives from multifamily bridge loans originated around 2021-2022: 

CRE CLO issuance surged to $45 billion in 2021, a 137% increase from two years earlier, when buyers of apartment blocks sought to profit from the wave of workers moving to the Sun Belt from big cities. Three-year loans would give them time to complete upgrades and refinance, the thinking went.

Fast forward to today and the debt underpinning many of the bonds is coming due for repayment at a time when there’s less appetite for real estate lending, insurance costs have skyrocketed and monetary policy remains tight. Hedges against borrowing cost increases are also expiring and cost significantly more to purchase now.

Those blows helped increase multifamily assets classed as distressed to almost $10 billion at the end of March, a 33% rise since the end of September, according to data compiled by MSCI Real Assets.

Last Wednesday, the Fed left interest rates unchanged at around 550bps as inflation data reaccelerates and economic growth tilts to the downside, stoking stagflation fears. 

Fed swaps are pricing in just under two cuts – this is down from nearly seven earlier this year and about 1.14 before last week’s FOMC. 

Meanwhile, bears are piling in on CRE CLO issuer Arbor Realty Trust Inc., with 40.3% of the float short, equivalent to 73 million shares short. 

“The multifamily CRE CLO market was not prepared for rate volatility,” said Fraser Perring, the founder of Viceroy Research, which has placed bear bets against Arbor, adding, “The result is significant distress.” 

The longer the Fed delays rate cuts, the worse the CRE mess will get.