Commercial Real Estate Crash: Lower Interest Rates Won’t Save Offices
Any hopes that lower borrowing costs would stem the pain from the US office market downturn were dashed this week.
Deutsche Bank WHY to save more money to sour U.S. commercial real estate loans, while a Slat Inc. Mortgage Trust cut its dividend. Shares of New York Community Bancorp then fell the most since the CRE-related turmoil in March after its loss provisions doubled the average of what analysts expected.
The announcements suggest that lenders may not be able to simply modify and extend loans in the hope that lower interest rates will ease borrowers’ pain and give property owners more time to debt refinancingMore than $94 billion of commercial real estate in the United States is currently in distress, with another $201 billion at risk of falling into that situation, according to MSCI Real Assets.
“When the $1.5 trillion debt maturities wall hits in the next two years, the consequences will be profound,” John Murray and François Trausch at Pacific Investment Management Co. Written in a note this week. “Lenders and borrowers will be forced to ‘face reality’: In the near term, we expect valuations and price indices to continue to decline, making loan extensions even less affordable.”
The bad news began when Deutsche Bank said the U.S. office sector would continue to weigh on earnings in the coming months, although it expects CRE provisions to be lower in the second half. Later in the day, Blackstone Mortgage Trust Inc., a target of short sellers, reported a quarterly loss of $61 million for the trust, compared with a profit of $101.7 million in the same period a year earlier. It cut its dividend by 24%.
The next day, New York Community Bancorp said it set aside an additional $390 million in the second quarter to cover loan losses, mostly from office lending.
“Higher impairments suggest that asset repricing could still be taking place at lenders and others with exposure to real estate,” Tolu Alamutu, a senior credit analyst at Bloomberg Intelligence, said of the industry outlook. “As transaction volumes pick up, further corrections cannot be ruled out. These signs may be fainter than last year but could still be reverberating.”
Credit investors remain confident that the turmoil from CRE will be contained, with risk premiums on bank bonds rising less than the broader market, suggesting they are outperforming.
Private credit
Private lenders see opportunities to profit as borrowers approach maturity. CRE debt funds are looking to raise about $50 billion in capital in the near term, with some considering buying distressed loan portfolios from banks, according to researcher Green Street.
“With strong liquidity, rapid redemptions and an emerging investment pipeline, BXMT is well positioned to deploy accumulated capital in this environment and continue its growth trajectory through the cycle,” Katie Keenan, managing director of Blackstone Mortgage Trust, said in a statement.
Murray and Trausch at Pimco wrote that there are opportunities for investors in both high- and intermediate-grade bonds, although they warned that the damage to CRE will persist even if the Federal Reserve begins to ease monetary policy.
They said forward curves showed borrowing costs would cause business asset values to fall by 20% to 40% from their 2021 peaks, adding that “the ongoing headwinds in the commercial real estate market will mean a significantly slower recovery than after the global financial crisis”.
