Why Hasn't the Distress Been Worse?

The office market is leaving many CRE professionals, economists, policymakers, and others scratching their heads.

Refinancing is tough. The Federal Reserve and bankers keep warning their concern over the state of loans. Gig waves of maturity are reportedly about to hit at a time when lenders are cautious, if not outright wary like banks, and the expense of refinancing at higher rates and lower leverage can make a property seem unworthy of a fight.

And yet, the worst hasn’t seemed to happen. As John Chang, senior vice president of research services for Marcus & Millichap said in a video, “a lot of people have been really surprised that the distress levels aren’t far worse than we’ve seen so far.”

The Wall Street Journal quoted data from MSCI Real Assets that said in 2023, only 3.5% of all U.S. office deals were the result of a distressed seller. In January 2024, the percentage dropped to 2.7%. That is even with vacancies rising from 11% in 2019 to 17% now.

It was supposed to be an avalanche, not a faucet with a worn washer. “Institutions have created enormous opportunity funds focused on targeting distressed assets, billions of dollars of dry powder waiting for what many to believe an inevitable outcome,” Chang said.

He added that currently, according to MSCI data again, of all asset types on average, only office are now valued below where they were in the last quarter of 2019. That’s why, if any property type faces a slap-down, it is office. And yet, data doesn’t show a whiplash.

“Of the $35.8 billion of office loans that came due in the commercial mortgage-backed securities market last year, only a quarter were paid off in full, according to data from real-estate analytics firm CRED iQ,” the Journal wrote. “Other loans were extended or sent to a special servicer—a third party that tries to find the best outcome for the debt, which may include modified payment terms or foreclosure.”

That still doesn’t explain the quiet. The economy has been strong, meaning that tenants could largely continue paying their rents. Lenders have worked with borrowers to put off the day of final reckoning because the former didn’t want to recognize losses on their balance sheets. As the Journal pointed out, of about 600 defaulted CMBS loans that went to a special servicer since 2022, lenders only recognized a loss in five cases, according to CRED iQ data. There are multiple large firms that have started distressed office credit funds, as GlobeSt.com has previously reported. Sources of capital could help delay the onset of a market meltdown.

But as the Journal also noted, CBRE estimates that “office landlords face a $72.7 billion refinancing shortfall between now and the end of 2025.” That is why, while things haven’t yet imploded, the near future is likely far from safety.