Office buildings continue to struggle in the post-pandemic era,
but our Chief Fixed Income Strategist notes that other properties
have turned a corner.
----- Transcript -----
Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan
Stanley’s Chief Fixed Income Strategist. Along with my colleagues
bringing you a variety of perspectives, today I'll be talking
about how the challenges facing the US commercial real estate
markets have evolved and talk about where they are headed next.
It's Wednesday, Sep 11th at 10 am in New York.
Over the last year and half, the challenges of commercial real
estate, or CRE in short, have been periodically in the spotlight.
The last time we discussed this issue here was in the first
quarter of this year. That was in the aftermath of loan losses
announced by a regional bank that primarily focused on
rent-stabilized multifamily and CRE lending in the New York
metropolitan area. At the same time, lenders and investors in
Japan, Germany and Canada also reported sizable credit losses and
write-down related to US commercial real estate.
At that time, we had said that CRE issues should be scrutinized
through the lenses of lenders and property types; and that saw
meaningful challenges in both – in particular, regional banks as
lenders and office as a property type.
Rolling the calendar forward, where do things stand now?
Focusing on the lenders first, there is some good news. While
regional bank challenges from their CRE exposures have not gone
away, they are not getting any worse. That means incremental
reserves for CRE losses have been below what we had feared. Our
economists’ expectations of Fed’s rate cuts on the back of their
soft-landing thesis, gives us the conviction that lower rates
should be an incremental benefit from a credit quality
perspective for banks because it alleviates pressure on debt
service coverage ratios for borrowers. Lower rates also give
banks more room to work with their borrowers for longer by
providing extensions. For banks, this means while CRE net
charge-offs could rise in the near term, they are likely to
stabilize in 2025.
In other words, even though the fundamental deterioration in
terms of the level of delinquencies and losses may be ahead, the
rate of change seems to have clearly turned. In that sense, as
long as the rate cuts that we anticipate materialize, the worst
of the CRE issues for regional banks may now be behind us.
From the lens of property types, it is important not to paint all
property types with the same brushstroke of
negativity. Office lots remain the pain point. Looking at
the payoff rates in CMBS pools gives us a granular look at the
performance across different property types.
Overall, 76 per cent of the CRE loans that matured over the past
12 months paid off, which is a pretty healthy rate. However, in
office loans, the payoff rate was just 43 per cent. Other
property types were clearly much better. For example, 100 per
cent of industrial property loans, 96 per cent of multi-family
loans, 89 per cent of hotel loans that matured in the last 12
months paid off. The payoff rates in retail property loans were a
bit lower but still pretty healthy at 76 per cent, in clear
contrast to office properties. Delinquency rates across property
types also show a similar trend with office loans driving the
lion’s share of the overall increase in delinquencies.
In short, the secular headwinds facing the office market have not
dissipated. Office property valuations, leasing arrangements and
financing structures must adjust to the post-pandemic realities
of office work. While this shift has begun, more is needed. So,
there is really no quick resolution for these challenges which we
think are likely to persist. This is especially true in central
business district offices that require significant capex for
upgrades or repurposing for use as residential housing.
Overall, we stick to our contention that commercial real estate
risks present a persistent challenge but are unlikely to become
systemic for the economy.
Thanks for listening. If you enjoy the podcast, please leave us a
review wherever you listen to this and share Thoughts on the
Market with a friend or colleague today.
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