According to Moody’s Investors Service, office-loan delinquencies in the commercial mortgage-backed securities (CMBS) market have reached a five-year high in November and are expected to further rise in 2024.
Rising Delinquency Rates
The rate of office loans that are at least 60 days past due increased to 5.28% in November, up from 5.14% in October, as per the latest Moody’s data. The CMBS market involves the bundling of debt on various property types, such as office buildings, hotels, and shopping malls, into bond deals that are then sold to investors.
Anticipated Increase in Delinquencies
Darrell Wheeler, the head of CMBS research at Moody’s, stated that delinquencies in this sector are expected to grow in the upcoming months. Many borrowers who had financed their properties at low rates now face higher borrowing costs due to maturing debt. Moody’s estimates that approximately $3 billion worth of maturing CMBS loans from various property types within the past decade could pose a challenge for refinancing.
Factors Influencing the Market
Wheeler emphasized that it is not just the office sector facing difficulties. He mentioned that the Federal Reserve’s decisions regarding interest rates and the stability of the U.S. economy will play significant roles in shaping the future of the commercial real estate market.
Uncertainty Surrounding Treasury Rates
Wheeler highlighted the impact of recent Treasury rate fluctuations on borrowers. While some individuals may be inclined to lock-in rates following the recent rally in Treasurys, the market remains highly uncertain. Wheeler noted that the current levels of Treasury volatility are unprecedented.
The Role of Treasury Yields
The 10-year Treasury yield BX:TMUBMUSD10Y soared to 5% in October but later declined as expectations grew for the Fed to implement rate cuts in 2024. This benchmark rate serves as a financing reference for both the commercial real estate market and the broader U.S. economy.
New Year Begins with Stable Interest Rates
Despite experiencing high volatility in rates throughout the previous year, the 10-year bond rate has kicked off the new year in a relatively stable position. Starting out at approximately the same level as it did in 2023, the rate is currently trading at around 3.905% yield.
Federal Reserve Considers Further Interest Rate Hikes
The Federal Reserve’s mid-December meeting minutes, published on Wednesday, revealed that U.S. central bankers have not ruled out the possibility of additional interest rate hikes. This news comes amidst a backdrop of strong performance for stocks towards the end of 2023. Both the Dow Jones Industrial Average (DJIA) and the S&P 500 index (SPX) experienced record highs. However, stocks ended on a lower note this Wednesday.
Borrowing Costs Remain a Challenge for Property Owners
Last summer, as the Federal Reserve increased its policy rate range to 5.25% to 5.5%, borrowing costs rose significantly. These higher rates have been a cause of concern for property owners. Despite this, they have also contributed to reducing inflation from its peak of 9.1% without triggering a recession in the U.S. economy.
Mixed Fortunes for Different Real Estate Sectors
While hotels, multifamily properties, and industrial properties have thrived due to a robust labor market, the office sector has experienced a decline in revenue. Moody’s data shows a sharp drop in this sector. Many tenants are opting to renew office leases at lower rates and with reduced space. Although a recession appears less likely in 2024, it could exacerbate the challenges faced by the office market.
Commercial Property Debt and Risk to the Financial System
The Mortgage Bankers Association states that approximately $1.2 trillion in U.S. commercial property debt is set to mature by 2025. In December, regulators identified commercial real estate as a top threat to the financial system in 2024. However, despite these concerns, experts predict that overall CMBS loan delinquencies, which were at 4.87% in November according to Moody’s, will likely remain below 6% in 2024.