U.S. commercial real estate loan activity expected to decline in Q4 after Q3 recovery -DBRS

Issuance of securities backed by U.S. commercial real estate loans saw a rare rebound last quarter, but the sector’s woes are expected to persist through 2023, according to ratings agency DBRS Morningstar.

The third quarter saw the issuance of approximately $3 billion in new collateralized loan obligations (CLOs) backed by CRE loans, according to a report released Friday by DBRS.

This is a significant change from the second quarter, which saw less than $1 billion in CLO CRE issuance.

Despite last quarter’s rebound, DBRS analysts said they expected a decline in issuance volume in the fourth quarter, due to continued issues such as high interest rates and vacancies.

“The modest volume spike in the third quarter may have represented several quarters of origination volume by issuers, so with the latest transaction, it will take time for them to accumulate enough collateral for the next transaction,” the analysts write.

Total issuance for 2023 is expected to be less than $10 billion, which is well below market expectations, the report said.

Office-backed loans accounted for nearly half of all CRE delinquencies in the third quarter, according to DBRS. Office owners across the country continue to face several challenges, including the post-pandemic trend of remote work.

However, loans on lodging properties saw the largest quarter-over-quarter increase in delinquencies, according to the report, rising from 0.28% in June to 3.40% in September. Loans secured by self-storage properties saw the second largest quarterly increase in defaults.

According to DBRS, the overall default rate of 3.27% for CRE CLOs in the third quarter roughly matches the rate in the second quarter. As of September, delinquent CRE CLO loans totaled $2.67 billion, an increase of $20 million from the second quarter.

“DBRS Morningstar is aware that current interest rates and investment sales conditions have made loan refinancing and property sale exit strategies increasingly difficult for borrowers and, as a result, expects the majority of borrowers will need to exercise the built-in loan extension options,” the report said. (Reporting by Matt Tracy; Writing by David Gregorio)