US commercial real estate on fire despite interest rate cuts

Payment delays in the office market have reached the highest level since the financial crisis – concerns about structural problems outweigh joy about monetary easing

2013 New York City.

The crisis in the US commercial real estate market is expanding despite the Federal Reserve’s interest rate cuts. For loans for office buildings that are based on mortgage-backed securities, the late payment rate jumped to 9.4% in October, according to data service Trepp. This not only means a jump of one percentage point compared to the previous month – debtors in the segment are also under greater pressure than they have been since the worst phase of the market collapse in the wake of the 2008 financial crisis. This means that the office market also stands out negatively compared to other segments such as retail spaces, hotels and industrial facilities: on average, the proportion of late payments on commercial real estate loans is 6% overall.

The background to the distortions in the office market is a combination of structural problems and the Fed’s restrictive monetary policy between the beginning of 2022 and September of the current year. The construction boom of the previous decade in major cities is causing an oversupply of commercial space, while the home office trend is resulting in high vacancies in office buildings. In some of America’s largest markets, from Houston to San Francisco, 29 to 37% of space is unoccupied, according to real estate services provider Savills.

Asset quality under pressure

The difficulties in collecting payments even from the remaining tenants are putting the building owners in distress – and with it the banks that have issued them large-scale loans in rosier market phases. The analysts at S&P Global warn that the asset quality in the balance sheets of US financial institutions is in a downward trend and, in addition to the credit card business, which is characterized by high default rates, point to the commercial real estate market as a central source of problems.

Large-scale defaults are already a reality in the segment, causing volatility in the market for mortgage-backed securities. And, according to analysts, the high number of sometimes prominent debtors who are in arrears with their rent gives an idea of ​​the amount of write-offs that regional financial institutions in particular are still facing. Additional problem: Loans for which the debtor still pays the interest but ultimately cannot pay off the mortgage itself are not included in Trepp’s data.

Fight for survival into the new year

As a result of the upheavals, industry representatives have proclaimed the slogan “Survive till 2025” – survive until next year, then the Fed’s interest rate cuts will save the market. In fact, a large part of the segment is financed through loans with variable interest rates, which are linked to the Sofr interbank interest rate and closely follow the US Federal Reserve’s short-term policy rate. But on the one hand, after their major interest rate cut in September, the monetary authorities only resorted to a cut of 25 basis points last week and remained tight-lipped about the further course. And on the other hand, analysts emphasize, monetary easing does not solve the problem of structural oversupply of commercial real estate.

The sales prices of old office towers, even in the New York market, which was once characterized by scarcity, have fallen by 50 to 70% in the current year compared to the previous transaction. UBS recently sold off a building on 50th Street in Manhattan, which one of its investment funds bought in 2006 for $332 million and spent $76 million on renovating, for $8.5 million via an online auction. The major Swiss bank sold the property on which the tower stands in 2019 for $285 million to the real estate investment trust (Reit) Safehold, thereby making a small profit of $6 million, which was offset by the losses from the deal far outshine.

High need for refinancing

At the same time, according to Trepp, commercial real estate loans worth trillions will have to be refinanced in the United States by the end of 2028 – and interest rates are still high despite monetary easing. The sums threaten to overwhelm the market, especially since the alternative of refinancing via fixed-interest loans has disappeared. After all, the fiscal plans of the newly elected US President Donald Trump have recently given a strong boost to long-term interest rates. The commercial real estate market is probably still in for a hot phase.

A structural oversupply is causing a deep crisis in the US commercial real estate market. The rate of delinquencies on office loans has soared to its highest level since the 2008 financial crisis, despite interest rate cuts by the Federal Reserve. This poses serious challenges for America’s financial institutions.