The Inside Look with Xander Snyder - Episode 11

In this episode of ‘The Inside Look,’ Senior Commercial Real Estate Economist Xander Snyder discusses what the CRE market should expect as $1 trillion in outstanding loans come to maturity in the next two years.

Hi, I'm Xander Snyder, and this is First American's Inside Look.

With more than $1 trillion of commercial real estate loans coming due in the next two years, many have rightfully wondered what borrowers will do when their loans mature and they need to refinance them at higher interest rates. In short, when is the proverbial shoe going to drop for the commercial real estate sector? The thing is, all of this distress will probably not occur in a single shock moment.

Losses from distressed sales will happen gradually, one at a time, not all at once. Examples of such distress, especially in the office space, are already occurring. One loan that's been in the headlines has been a commercial mortgage-backed security, or CMBS, for a large office building in New York City. The property was purchased in 2014 for $605 million, roughly half of which was financed with this CMBS loan and the remaining portion with the buyer's equity.

In 2022, the owner of this building handed the keys back to the special servicer, which means that it took a complete loss on its equity position. Now, at that point, the special servicer’s job is to find the best resolution for the investors in the debt portion of the capital structure. Some important context – CMBS are regularly sliced into different tranches. Lower tranches receive higher interest income but are also the first to lose money if the full amount of the loan can't be recovered.

And in April of this year, that loan was sold at an effective 62% discount, including some deal-related fees, which resulted in all note holders taking a complete loss except for those in the highest-rated tranche, the Triple-A tranche. Now, investors in that Triple-A tranche, though, did lose about a quarter of the money that they invested. In fact, the Triple-A tranche loss is really the reason that this note sale has attracted so much attention because it's the first time that a triple A tranche in a CMBS has taken a loss at all since the aftermath of the global financial crisis in 2008-2009. In total, less than 20% of the funds used to purchase the building in 2014 were recovered from this note sale.

Additionally, in 2021, before the prior owner took a complete loss, the office’s largest tenant, which accounted for nearly 70% of the space, moved out and did not renew its lease. Now, despite the well-known problems in the office sector, not all buildings are facing such severe occupancy declines. Still, office defaults that do happen will occur one at a time, a number of individual body blows to specific properties rather than an all-at-once knockout punch to the sector.

My colleague Odeta Kushi and I will be having a conversation on the state of the commercial real estate economy in a webinar on July 17th. If you want to sign up, you can check out our social media pages @XanderSnyderX for me and @odetakushi for Odeta, where we'll be sharing sign up links. Additionally, I'll be giving a handful of talks this September in the Midwest in Cleveland, Columbus, and Indianapolis. If you're interested in attending any of these, please reach out to your local First American representative.