Distressed office loans will likely “pile up” into 2023, according to experts from Trepp, who predict there will be billions in unresolved office loans by year-end.
“Maturity dates will come and go; loans will reside in CMBS purgatory for months; negotiations will take considerable time; and ultimately many loans will be extended,” says Manus Clancy, Senior Managing Director at Trepp. “Borrowers will be happy to lock in lower rates for longer and special servicers will rejoice.”
Lonnie Hendry, SVP, Head of CRE & Advisory Services at Trepp, foresees a “measurable number of liquidations at steep discounts,” adding that so-called “bad” office properties will trade at significant discounts while “borderline” properties in strong markets remain in CMBS purgatory.
Trepp experts differ on where exactly the 10-year Treasury yield will end 2023, but agree it will be under 4%. Clancy says “the economy will slow enough so that long-dated Treasury yields will continue to drop,” while Hendry predicts the 10-year will remain above 3% in 2023 but will be less than 4%.
“Predicting the 10-year Treasury is like playing old-school lawn darts (ones with the metal tip that got pulled from the market after people were impaled),” says Stephen Buschbom, Research Director at Trepp. “We all love to play, but accuracy is low, and being on the wrong side of things isn’t pretty. We could see steep inversion between Fed funds and the long end as the market continues to price what comes next (2024 pivot if you believe the Fed). But, if inflation runs higher than 2% for longer, and there’s a general ‘risk-on’ sentiment for equities in the second half of ‘22, then a range of 3-3.25% seems feasible.”
According to Rob Jordan, Trepp’s Head of CMBS Product, a lower 10-year rate “would certainly help thaw” the slumping CMBS market. Domestic private-label CMBS issuance nosedived in Q3 2022, with a total of 16 deals totaling $13.3 billion priced during the quarter, down 35% over Q2 and 39% year over year. Meanwhile, the collateralized loan obligation market saw just four deals totaling $3.39 billion price in Q3.
Jordan notes that issuance of new CMBS product “takes a decent amount of time to line up,” adding that warehouse lines are harder to procure and bank balance sheets are becoming more selective.
“It may take longer than through the first half (of the year) to get to a point where borrowers and lenders are agreeing on pricing and leverage points, given the ongoing interest rate volatility,” he says. ” With approximately $450 billion of CRE mortgage maturities across lenders (only $15 billion in CMBS), it will be interesting to see which pockets of capital adjust the fastest to the new rate regime.”
His colleagues seem to agree: “ There’s little reason to think the second half of 2022 will make up for a weak first half,” Buschbom says. “It wouldn’t surprise me if we end up seeing issuance +/- 2020 levels.”
CMBS delinquencies will likely rise to between 4 and 5%, Trepp’s panel of experts agree.
“Loans unable to be refinanced push the number up steadily in 2023. Negotiated loan extensions/modifications keep the number from being higher,” Clancy says. ”Conduit hotel and retail segment remain surprisingly resilient, but office and SASB markets underperform.”
Adds Hendry: “I think we could see the delinquency rate hit 5% by the end of 2023 if the office maturity wall collapses.”