The Commercial Real Estate Dumpster Fire Burns On

Commercial landlords can’t pay off mortgages … rising defaults … but have regional banks been de-risked? … Bill Gross’ recent bank trades … how the sector looks through Stage Analysis

The dumpster fire that is the commercial real estate sector continues to burn.

According to Moody’s Analytics, during the first nine months of 2023, only one out of three expiring securitized office mortgages were paid off.

Here’s The Wall Street Journal from yesterday with more:

That is the smallest share for the first nine months of any year since at least 2008 and well below the nadir reached in 2009, when 47% of these loans got paid off.

That share is also well below the rate before the pandemic, when more than eight out of every 10 maturing securitized office mortgages were paid back in some years.

Regular Digest readers know that we’ve been running a “commercial real estate watch” segment all year, monitoring this critically important sector of the U.S. economy.

Legendary investor Warren Buffett once quipped, “You only find out who is swimming naked when the tide goes out.” Well, with Federal Reserve Chairman Jerome Powell saying there’s zero discussion of rate cuts on the table, and with $1.4 trillion in commercial real estate debt coming due by the end of next year, the tide is going out…

And no sector has more “naked swimmers” than commercial real estate.

***What the numbers tell us about the commercial real estate meltdown

The WSJ article explains that many office owners can’t pay back their old loans because they can’t get new mortgages.

To make sure we’re all on the same page, the office sector relies on debt. Landlords buy astronomically priced buildings with huge mortgages. When the mortgages mature, the landlords can’t pay off the building in full, so they just take out a new mortgage.

The post-Covid trend of remote work has resulted in a wave of office vacancies that have pushed down rental rates (slashing revenues for the owners).

Meanwhile, the Fed’s rate hikes have boosted financing (and refinancing) costs, while also pushing down building values (due to higher discount rates).

Given these shifts, the mathematics just don’t work anymore for many new commercial mortgages. Back to the WSJ for the result:

That combination is fueling a rise in defaults. The share of office CMBS loans that are delinquent has tripled over the past year to 5.75%, according to Trepp.

To give you more perspective on just how bad it is, let’s compare 2023 with 2019.

Before the pandemic, when offices were full and interest rates were low, landlords could just roll over their maturing debt into new, low-rate loans. In the first nine months of 2019, 88% of commercial landlords paid off their loans at maturity (by rolling into new loans).

Last year, we began to see the first wave of refinancing contagion during this new era of higher vacancies, higher rates, and lower building values. That…