Fitch Ratings Says Recession Would Double CMBS Loan Delinquency Rate

Fitch Ratings expects the US CMBS loan delinquency rate to increase from the 1.89% of October 2022 to between 4.0% and 4.5% by the end of 2023. The causes, according to the firm, are higher interest rates, persistent inflation, and weak economic growth, with a mild recession starting in the middle of next year.

“Fitch expects higher delinquency rates for all major property sectors next year,” the firm wrote. “Retail and hotel rates, which are the highest across all property types, will increase further, and multifamily, office and industrial rates will exceed their pandemic peaks.”

The projection includes expectation of “substantially more new delinquencies,” particularly maturity defaults. Special servicing will still exist but at lower levels because of the same factors that will lead to increased defaults and distressed sales, as many in CRE have been telling GlobeSt.com: higher refinancing costs, pressures on CRE fundamentals like rents, and increasing cap rates. A property facing refinancing will see higher debt burdens and possibly a demand for less leverage, so a need for additional capital from investors. But rent growth has slowed everywhere and it frequently won’t maintain previous net cash flows.

Delinquency rates will rise for all major property types. “Retail and hotel rates, which are the highest across all property types, will increase further, and multifamily, office and industrial rates will exceed their pandemic peaks,” Fitch wrote.

More specifically by type, retail will face inflation and slowing wage growth pressure on consumers, which in turn affects retail revenue and ability to pay rent. Fitch projects that many maturing Class B and C mall loans will default.

Although hotel delinquency will increase, Fitch doesn’t expect it to return to pandemic highs of 18.4%. “Forward room bookings and pricing expectations are strong for 2023, driven by improving group room nights and healthy leisure demand,” the agency wrote. “While 2023 is not expected to match the strong recovery of hotel performance metrics in 2022, a recession will further delay ultimate recovery to pre-pandemic performance.”

In office, it is the older and lower quality B and C properties that face the greatest risk of default, with hybrid work arrangements and less need of office space, increased costs, and tenants that move to higher quality offices.

Multifamily is in relatively good shape compared to other types, with home prices and consumer mortgage rates keeping many who would otherwise have purchased a house to remain in rental housing. But there will be cash flow deterioration as expenses rise while rents moderate and eventually come down.

Industrial, while still in demand, will see a slowing of rent growth as an effect that a recession would have on business in general.