Delinquencies Low, Patience High As CRE Works Through 'Tipping Point' of Distress

Commercial real estate has hit a “tipping point” that’s “only going to accelerate over the next few years, according to one industry insider.

“I think we’re going to go through a period of workouts now. I think we’ll come out of it…I think that the real estate industry is cyclical and it is very, very nimble and adaptive,” Goodwin’s Minta Kay told CBRE’s Spencer Levy on a recent podcast. “I am very confident and I believe highly that innovation is going to drive a lot of how the landscape is shaped and how the community invests and chooses to place its money going forward. I don’t think we’re any more old bricks and mortar and that’s it.”

Delinquencies are also on the decline, according to CWCapital’s James Shevlin, who says the CRE market is “resilient” and will be bolstered by technological advances in the near term, particularly in the data space.

The predictions come as courts, lenders, and landlords have a new level of patience previously unseen in prior financial crises.

“There is no one playbook for what’s happened in 2020 and 2021,” Kay told Levy. “The economy has certainly supported ongoing investment in real estate, but it is without a doubt that there’s a tremendous amount of default on the debt side and that there is stress in the industry…I think the fact that the distress is driven by a health pandemic as opposed to a pure financial crisis has really changed the attitude and the ways that constituencies have behaved.”

The pandemic “started out as a liquidity crisis,” Shevlin told Levy, but values have held up. He noted that his firm’s special servicing book grew by 500% during the first few weeks of the COVID crisis, and “because it started out with no liquidity, not being able to make the payment, we had to quickly react and try to right-size the ships.”

The difference? The post-COVID recovery picture looks very different from the circumstances post-Great Financial Crisis.

“In the last crisis, it took multiple years to get to a recovery period,” he said. “We’re here. It’s happened much, much quicker. And, you know, there’s been a ton of money raised to support these declining assets and really rescue them from the initial trouble.”

That’s even been true for hard-hit asset classes like hospitality, where Kay says valuations are coming up and delinquencies are decreasing.

“From my perspective, what I see is that there’s been a lot of dual tracking in dealing with distress in that space,” she said. “So you’ve got lenders who are thinking about pursuing remedies…I think there’s been a double trajectory, a dual path that has led to more creative solutions than there has been enforcement, frankly. And some of the enforcement has been stalled and stopped.”

Shevlin agreed, noting that in the first few weeks of the pandemic, he received $20 billion in relief requests.

“Hospitality was probably the hardest hit,” he said. “No one was traveling and we had to step in to provide relief. So we did. We suspended replacement reserve collections. We switched some deals over to IO just to try to help them get through the crisis.”

As for office, Shevlin says the major differentiator is the fact that offices are longer term leases – “and depending upon when that office lease matures, that’s when you have to deal with the issue.”

“We’re really not seeing it in CBD office right now, the defaults in office. Will it happen at some point? Maybe,” he says. “The bigger concern is probably more suburban office as there’s a flight to quality now. That’s the first thing we should look for to see how suburban office performs. But our office book, our delinquency rate on the performing deals right now is 0.33 percent.”

Kay thinks some changes may be afoot for the sector, and warns that we may begin to see more stress as corporate America continues to grapple with what a post-COVID return to office may look like.

“I think we have a very mixed bag here. I don’t think we have one playbook,” she said. “We work with a lot of clients who are really developing different kinds of hub and spoke models, different kinds of sites, Main Street office sharing, that are really going to allow people who are working on a hybrid basis – some in some out of the office – to access professional working space. So I think office is TBD. We’ll see. But I think this is going to be the year that that’s very tested.”