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The Reckoning for Commercial Real Estate

July 26, 2023 by Forex Winner Leave a Comment

Big-time landlords are facing a reckoning as they begin to surrender struggling properties to lenders. This marks a significant shift from just a few years ago when these properties were fetching sky-high values amid super-low interest rates.

This surrendering of properties is considered by many to be the start of a major test of confidence for the estimated $20.7 trillion commercial real estate market, possibly the biggest since the 2007-2008 global financial crisis.

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According to Brian Lane, the lead analyst for private credit at the Well Fargo Investment Institute, there is a daunting $1 trillion “wall of worry” as a wave of commercial real estate loans come due by the end of 2024. This balance balloons to approximately $2.5 trillion by the end of 2027.

Lane wrote in a client note, “Property owners are facing higher vacancies, reduced net operating income, falling prices, and rising capitalization rates. While valuations have started to decline in most property types, there is likely more downside.”

A recent report by McKinsey predicts that prices for office buildings could fall by as much as 42%.

Morgan Stanley analysts have also weighed in, reiterating a call for overall commercial property prices to drop 27.4% from peak to trough by the end of 2024.

Given these challenges, Lane expects many borrowers to turn to private-capital providers for loans, as banks and the commercial mortgage-backed securities market begin to pull back.

“We anticipate that private investors will play a crucial role in providing debt financing, and that property sponsors may be compelled to infuse equity to protect their holdings and right-size property deals.”

Commercial Real Estate Still Attractive for Institutional Investors

Institutional investors in bonds have not given up on commercial real estate. According to Saira Malik, Nuveen’s chief investment officer, “nonoffice” commercial mortgage-backed securities are currently offering attractive yields of 10.6%. This is in comparison to the roughly 5.5% yield on investment-grade corporate bonds and the 3.87% yield on 10-year Treasury bonds. Malik highlighted that despite regional-bank failures and challenges in the office sector, delinquency rates on loans in bond deals remain low at about 2%, significantly below the 9% rate during the global financial crisis.

Malik suggested that investors should consider commercial real estate for its higher yields and total returns, especially given the expectation that the Federal Reserve will soon end its aggressive cycle of rate hikes.

In the stock market, the Dow Jones Industrial Average experienced its 11th straight session of growth on Monday, reaching its highest level since February 2022. The S&P 500 index closed at 5% below its record close on January 3, 2022.

Read: Do Not Disturb: Tenants brace for more office landlords to go belly up on their property debts

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