$17B of Office-Backed CMBS Due in 2023

On the heels of a report that nearly a third of new CMBS issuance was afflicted with negative leverage in the third quarter comes the sobering realization of a potential reckoning to come: more than $17B of mortgage bonds back by office buildings come due in 2023.

That’s more than double the $7B that are coming due by the end of this year and more than four times last year’s total of $4B, according to Trepp LLC.

The wave of CMBS maturation is coming at the worst possible time for office building owners, who are confronting what CRE experts are calling a “secular repricing” of office buildings on a scale not seen since the Great Recession in 2008.

The prices of aging office towers in some major urban centers like New York and Chicago have fallen about 25% as potential buyers have a hard time lining up financing with interest rates surging and lenders getting cold feet about issuing mortgages against office properties, according to brokers and lenders surveyed by the Wall Street Journal.

The primary concern is that the combination of rising interest rates and declining building values—and lenders who are increasingly reluctant to issue mortgages against office properties—puts many landlords into a position where they have no choice except to borrow smaller amounts at higher rates or turn the keys over to the lender or a buyer who accepts the deed in lieu of foreclosure.

So, the stage may be set for a wave of defaults accompanying the wave of CMBS due dates in 2023. According to WSJ, defaults are starting to move up from low levels.

However, the leading indicators thus far show no cause to pull the fire alarm: Trepp’s latest CMBS delinquency rate, issued this week, showed a modest increase in October of 2.96%–only 4 bps higher than September’s level.

“Whether this is the beginning of a turning point as a result of higher interest rates and a slowing US economy or just a momentary bump remains to be seen, Trepp’s new report said.

“CMBS investors have been watching carefully for signs of distress. It is expected that the higher refinancing costs could make it difficult for some marginally performing assets to be refinanced,” Trepp added.

In its new report, Moody’s interpreted the Q3 surge in negative leverage in new CMBS issuance as an ominous inflection point for CRE.

According to Moody’s, about $5.5B of CMBS—equivalent to about 28% of the mortgage-backed securities that were issued in Q3—were symptomatic of negative leverage in which the cost of debt is exceeding projected returns on investment, including projected rent increases.

This represents a huge spike from the 8% of negative leverage in CMBS detected in the second quarter and a quantum leap from the Q3 2021 level of 2%, Moody’s reported. Moody’s said it was seeing a spike in negative leverage across asset classes, with the largest jumps seen in the industrial (35.9%) and multifamily (30.8%) sectors.

Investors calculate a building’s capitalization rate by dividing the property’s profits before mortgage payment by the purchase price. A capitalization rate that is lower than the interest rate on the mortgage usually is a red line in terms of risk—and interest rates are now poised to rise beyond 7% as the Fed signals that a series of hikes—perhaps at 50 bps a pop instead of 75 bps—are on the horizon.

According to the Mortgage Bankers Association, the total outstanding commercial/multifamily mortgage debt hit $4.9 trillion at the end of Q2 2022.