Inman Connect Las Vegas is LIVE this week! Get all your real estate questions answered and network with thousands of industry leaders. Join us virtually from anywhere in the world — the future of real estate is unfolding now.
After years of post-pandemic struggles, the commercial property market may at last be near-bottom after a quarter in which foreclosures hit their highest rate in nearly a decade.
TAKE THE INMAN INTEL INDEX SURVEY FOR JULY
Portfolios of foreclosed and seized office buildings, apartments and other commercial buildings hit $20.5 billion during the second quarter of 2024, according to data provider MSCI’s Capital Trends most recent report. That figure is 13 percent higher than Q1 2024 and the highest quarterly figure posted since 2015.
The commercial market has seen a rise in defaults and other distress in recent years as a result of the slow return of office workers and rising interest rates. Despite those rising numbers of defaults, lenders have held off on taking over properties, hoping that a recovery was in sight — and that they could avoid expensive foreclosure actions.
“Lenders will do everything in their power to avoid that,” Keefe, Bruyette & Woods analyst Jade Rahmani told The Wall Street Journal.
An increasing number of lenders have determined that office buildings may never recover their previous values, even after rates decline, which is leading to more foreclosures and short sales.
Commercial property values could continue to decline if the U.S. goes into a recession, causing companies to start laying off workers and, therefore, require less office space.
Based on similar spikes in foreclosures during previous downturns, market bottom may be close at hand. Lenders typically sell properties shortly after seizing them, which helps determine market value after extended periods of inactivity.
Offices have been hit the hardest, with the volume of office property seized through foreclosures and other actions up by $5 billion year over year, according to MSCI. Meanwhile, apartment buildings, which have also suffered amid high interest rates and growing supply, saw an increase of $975 million in portfolio volume seized since the second quarter of 2023.
A number of high-profile commercial properties have been seized as of late, including a five-building Silicon Valley complex owned by a venture of Goldman Sachs and TMG Partners, which was taken over by KKR Real Estate Finance Trust. KKR held a $200 million mortgage on the property and took title at the end of June in a deed in lieu of foreclosure transaction. The trust is expected to start marketing the complex shortly after making upgrades.
In Washington, D.C., where the office market has struggled, several buildings have sold at steep discounts. State Farm Life Insurance recently made a foreclosure sale of an office building just blocks from the White House. The property sold for $17.6 million, which was a roughly 70 percent discount from the owner’s original purchase price in 2010.
According to developer Matt Pestronk, who has purchased two discounted office buildings in D.C., “Lenders are more dispassionate about values, and that’s a sign of a cycle moving” toward bottom.
Small banks with fewer assets (especially under $10 billion) have adopted foreclosures at a quicker clip. The total value of seized commercial properties these banks owned during Q1 rose by roughly $125 million from the previous quarter to $943 million, the largest quarterly spike since 2000, bank data consultant Matthew Anderson told The WSJ.
Even if the Fed begins to cut interest rates in the fall as analysts anticipate, the commercial market is expected to take a long time to recover — and some office buildings may never recover their lost value. The sector’s risk will extend “probably for years,” Fed Chairman Jerome Powell said in a Senate testimony earlier in July.
Regulators are concerned about that prognosis for the industry because of the implications it could have on the financial system at large. More than $2.2 trillion in debt maturities are expected to come due between now and 2027, according to data firm Trepp.
Signature Bank’s failure last year serves as an early sign of what may come for other banks that have a high exposure to commercial property.
Investors have pumped cash into other banks holding vast quantities of commercial loans in order to stave off such failures, including First Foundation and New York Community Bancorp. On Thursday, the latter’s shares dropped more than 3 percent after disclosing another quarterly net loss.
Another foreboding sign is the increase in problem loans that many creditors are facing, including Blackstone Mortgage Trust (which has a large exposure to office loans). Last week, the company cut its dividend and increased loss reserves by 19 percent to over $900 million.
The delinquency rate of office loans converted into securities also jumped by 8 percent this month for the first time since November 2013, according to Trepp.
Despite growing concerns in the market, the number of foreclosures and other property seizures are still well below those seen during the 2008-09 financial crisis. In 2013, the number of foreclosed and seized properties held by lenders surged to more than $45 billion, more than twice the current rate, according to MSCI.
Since building owners have been more willing during this downturn to walk away from properties than in the last financial crisis, foreclosure figures may not ever reach the level seen during that time. At that time, owners wanted to hold onto low interest rates and hoped for a recovery.
“This cycle, a lot of investors believe office values are challenged,” Nicholas Seidenberg of real estate investment banking firm Eastdil Secured told The WSJ. “They’re saying: ‘Hey, I’m going to just walk away and not fight.'”
