Maybe Secret Distress Is Behind CRE Market Performance

There are signs of distress in CRE markets — jumps in distressed loan statuses and banks increasing CRE charge-offs — and yet the big wave of distress that everyone has been expecting doesn’t seem to have come. 

Marcus & Millichap CEO Hessam Nadji has said that all asset classes other than office have healthy fundamentals in occupancy and rents, and discounts a wave of fire sales. Then again, Joseph J. Ori, executive managing director of CRE advisory firm Paramount  Capital Corp. says that while there isn’t a collapse like during the Great Recession, further interest rate hikes by the Federal Reserve could double defaults from 2% to 4%.

So, perhaps the U.S. CRE market is waiting for the stage on the march to distress that may not be as bad as many had predicted. Or maybe — given some potential implications of a recent Green Street Real Estate Alert — the distress market is actually underway, only showing itself differently than expected.

The report noted that $38.89 billion of all properties changed hands in the first half of 2023. In comparison, that number was $55.12 during the same period last year. That was the biggest overall largest six-month decline since 2019. However, in the $25 million-plus category, sales were down 61% year over year. The $5 million-to-$25 million category fell, too, but only 29%.

One factor many sources have been telling GlobeSt.com is that any owner that wasn’t under pressure for an immediate refinance, which is most of them, could likely afford to wait for property values to recover. That would mean in effect a large number of distressed properties for which there was financial pressure in the sense of falling value that could upset expectations but not nearly enough to force a sale. Call that secret distress because it doesn’t show up so clearly.

The same would be true if a commercial bank made a loan and is working with lenders to keep from having to write off value on their books. None of the banks is keen on raising questions as to the soundness of existing assets and potentially sending depositors racing elsewhere.

Large institutions might consider taking advantage of distress purchases, but too much is up in the air. There is insufficient transaction volume for adequate price discovery, making it difficult to determine when things approach bottom. Those institutions could hold onto what they have and manage the existing income from cash flow, keeping abundant capital at hand (as many in the industry have said is happening), and wait. Or perhaps they want to buy with leveraged funds and find the current interest rates unappetizing.

Green Street also noted that many of the current “opportunities come from distressed sellers willing to accept discounts on properties for which they’re unable or unwilling to fund necessary capital expenditures.” That would make sense and also suggests that there is a significant amount of distress activity already happening. But conditions are far different than during the Global Financial Crisis, and as one expert had told GlobeSt.com in the past, back then, no one had faced such a major calamity and many panicked. Today, they know how to deal with it.