A Rise in Delinquency Rates
The commercial mortgage-backed securities (CMBS) market has been grappling with a rise in delinquency rates, particularly in the office sector. Delinquency rates serve as an important indicator of the health of the real estate market by providing insights into the financial health of individuals, organizations, and the overall economy. Therefore, the recent surge in delinquencies has sparked concerns among industry experts.
Delinquency Rates Reach High Levels
The month of May 2023 witnessed a noteworthy rise in the CMBS delinquency rate, increasing by 23 basis points to 3.62%. This increase marked the highest level observed in over a year. An influential factor contributing to this increase was the spike in office delinquencies, with the rate leaping by 125 basis points to 4.02%.
In addition to office properties, other sectors are also facing challenges with delinquency rates, as recorded by Trepp. Delinquency rates for the month of May were reported to be 6.67% for retail, 4.25% for lodging, 1.46% for multifamily, and 0.38% for industrial, the lowest delinquency rate for any property type.
Rising Delinquencies in the Retail Sector
In the retail sector, delinquency rates have been on the rise due to the presence of larger balance loans that have faced challenges in meeting debt service payments. In May, three of these loans accounted for 93% of the new retail delinquency volume. For instance, two loans re-entered Fitch’s delinquency index after falling behind on their payments once again. One of these loans, tied to the 1551 Broadway property in New York, NY, reported non-performing matured balloon status, while the other loan associated with the Westfield Countryside Mall in Clearwater, FL, experienced 60 days delinquency. Another notable delinquency was observed with the Fair Oaks Mall loan, secured by a regional mall in Fairfax, VA, which defaulted at maturity and was transferred to special servicing.
Shrinking Demand and Increased Sublease Space
The office sector has been grappling with significant challenges, mainly due to the dwindling demand from major tech firms and corporations rethinking their space needs as more workers work from home. This decreased demand has resulted in an excess of available office space for lease, with sublease space reaching or nearing record highs in numerous markets. As a response, many companies are actively downsizing their office footprints by allowing leases to expire or opting for smaller spaces during lease renewals.
A notable example exemplifying this trend is Google’s recent announcement to offer approximately 1.4 million square feet of office space in Northern California for sublease. This strategic move by Google reflects its shifting office space requirements and contributes to the surplus of available office space in the market.
Evolving Borrower Behavior
A factor contributing to the rise in overall delinquency rates is the shift in borrower behavior. Historically, loans that were past their maturity date but still had regular interest payments being made were not included in delinquency rates. This was because borrowers were often in the process of finalizing options to extend the loan repayment period, which was already included in the loan agreement. However, an emerging trend suggests that borrowers are increasingly forgoing these extension options, leading to a higher inclusion of such loans in delinquency calculations.
Year-Over-Year Comparison
According to Trepp, the overall CMBS delinquency rate has risen by 48 basis points on a year-over-year basis, indicating an upward trend. Moreover, the percentage of delinquent loans, including those 60+ days delinquent, in foreclosure, real estate owned (REO), or non-performing balloons, has also climbed by 49 basis points from the month prior, reaching 3.38%.
Takeaway
The upward trend in delinquency rates, particularly in the office market, can be attributed to reduced demand from tech firms, increased sublease space brought about by decreased demand for space with more workers working from home permanently, and changing borrower behavior. Moreover, factors such as loan defaults at maturity, non-performing matured balloons, and repeated delinquencies impact the overall delinquency volume for the retail sector. Stakeholders in these sectors must closely monitor these developments to navigate the evolving market conditions successfully.
