Distressed Sales Could Approach $126B in Next Two Years

Even if the CMBS delinquency rate retreats, the default amount is still rising.

CoStar Group expects a large scale of distressed sales to hit mid-2021. The company modeled 16 different scenarios to determine how bad the carnage would be from this recession. In those exercises, the amount of distress landed between $92 billion to $370 billion, though it will likely be $126 billion.

“It’s a pretty wide range,” says Xiaojing Li, managing director at CoStar Group. “We think it [the amount of distress] could be a blended scenario that is somewhere in the middle.”

Li says two of the forecast’s primary drivers were the unemployment rate and the CMBS default rate. CoStar also used supplementary drivers like the vacancy rate and the CRE asset value index. Under CoStar’s severe scenario, which yielded distress numbers at the high end of the scale, it had a 17% unemployment rate.

“We forecast the percentage of the distress and the sales volume of that entire CRE asset value,” Li says. “So this time definitely compared to 2008 and 2007, the pie is bigger. If you look at the overall CRE universe, there are $10 trillion of CRE assets for the core asset types. If you look at the number prior to the Great Recession, that is probably 60% of where we are right now.”

In 2021 and 2011, distress sales were $95 billion in 2010 and 2011. Part of the increase can be traced to the additional amount of commercial real estate in the market.

“From The Great Recession to now, there has definitely been a lot of new construction added to the market, as well as the inflation of CRE values,” Li says. “So that’s why the pie is bigger. So we applied the percentage to the bigger pie.”

Even with the smaller amount of distressed assets in the Great Recession, it took almost 10 years to settle all the troubled loans and distressed properties. CoStar believes the distressed sales process will again be prolonged, with $321 billion being sold by 2025. From 2010 to 2014, $192 billion was sold.

“The distress process is a long process,” Li says. “It takes some time for the loan to go from default to the foreclosure and REO process. For the loans going through that, it takes about two years.”

Once loans go through this process, there will be no shortage of groups ready to buy them at a discount. “We work with a lot of those institutions that they were definitely socking away cash [over the last several years] for something like this to happen,” says John Vecchione, vice president, Risk Analytics for CoStar. “We have not seen anything concrete as far as them investing or where they’re investing or how they’re doing it right now. That is something we’re actively monitoring and trying to figure out.”