CRE ‘Reckoning’ Looms

Storm clouds are gathering in the commercial real estate (CRE) market, and—you guessed it—office space is under watch. Experts at a recent discussion hosted by RMA’s New York Chapter warned of a potential “reckoning” in the office segment as a wave of maturing mortgages collides with a decline in demand. While other CRE sectors like multifamily are seeing strong investor interest (but not without risk), office buildings remain particularly vulnerable.

Here are some key takeaways:

• Maturing Loans Pose Default Risk: With a staggering $929 billion in commercial mortgages maturing in 2024 alone, according to the Mortgage Bankers Association, banks face a heightened risk of defaults. This is especially concerning for loans tied to struggling office properties, where extended loan terms may be masking underlying problems in valuations and delaying inevitable losses.
• Office Vacancies Threaten Property Values: Vacancy rates in office buildings are on the rise, raising concerns about a potential downward spiral. Panelists worried these rates could climb even higher, exceeding 20%, especially if a recession hits.
• Multifamily Market Remains Strong: In contrast to office woes, the multifamily sector is a bright spot, attracting significant investment capital. Panelists cited strong demand and “creative solutions” in lease negotiations as reasons for the multifamily boom. However, a lack of recent transactions in this market makes property valuation a challenge.
• Lower Rates May Not Be Enough: While lower interest rates could stimulate activity, panelists believe yields are still too high to spur significant new apartment construction. The long-term impact of interest rates on valuations remains unclear. Inflation, however, remains a top concern.

What can we expect? In the coming 12 months we are likely to see the true impact of these trends unfold. Banks are especially vulnerable as they grapple with a wave of maturing loans tied to potentially overvalued office properties. Defaults and losses are likely.

“The reckoning always comes,” warned panelist Christopher Albanese, president of a real estate development and management firm.