A Distress Avalanche Isn't Coming, According to This Firm

There has been an ongoing curiosity on the part of many, particularly investors, of when the distressed inventory will suddenly hit. For some, it’s a chance to pick up bargains that will eventually regain value. Others are worried about the effect a wave of distressed properties will have on other valuations.

The former group, at least, may be disappointed.

A recent Cushman & Wakefield analysis says that while the amount of distressed inventory will continue to growth, “it will not be an avalanche.”

According to the analysis, as of the third quarter of 2023 there was $79.6 billion in outstanding distressed properties. Of that, office was 41%; retail, 27%; hotel, 17%; multifamily, 9%; and industrial, 2%, based on data from MSCI Real Capital Analytics.

Now, that is as of October 2023. According to Cushman & Wakefield, using the same MCSI data, that could be nothing going forward. They say that the potential distress could be as much as $215.7 billion, or “larger than the cumulative distress observed during the entirety of the Great Recession.”

That is likely heavily resting on properties that had been financed at low interest rates with high leverage and then were maturing at a different time with high rates and low leverage. Refinancing realities have meant putting more capital into the deal, taking very expensive bridge loans in hope of a change in rates, or turning keys over to the lender.

But if the potential distress could be more than that during the Great Recession, how could there not be a big wave? Because the conditions are different.

Even as property values shot up rapidly during the pandemic and into 2022, so did rents. Also, C&W notes that “accumulated appreciation insulates current LTVs [loan to value ratios].” Those rents appear as expanded net operating incomes “considerably over the life of the average loan expiring over the next three years,” the company wrote. It added, “Estimated implied LTVs, given both accumulated appreciation and outstanding loan balances for properties purchased between 2010 and 2019, is 51.5%.” That is a sizeable cushion.

However, not an “avalanche” is far different from a dusting of snow. The implied LTVs accrued to properties purchased at the tail end of the Great Recession and up to right before the pandemic.

The properties not in that group are the ones purchased when prices were rising like a helium balloon on a clear and still day. Cap rates plummeted. Rent increases were necessary to make the projects pencil. That might be where the distress floats up.