The office real estate market is on the precipice of a challenging year in 2024, with looming loan maturities and refinancing issues casting a shadow over the sector. As interest rates rise and lenders scrutinize commercial real estate loans more closely, it appears that no real estate sector will emerge unscathed from the difficulties that lie ahead.
Moody’s Analytics Inc. has projected that approximately $182 billion worth of commercial real estate loans are set to mature among major property types in 2024. Notably, an estimated $47 billion of this total is expected to belong to the office loan segment. These insights, derived from an analysis of data from the Mortgage Bankers Association, the Federal Insurance Deposit Corp., and Moody’s own data, underscore the looming challenges faced by the office real estate sector, according to a report in the National Observer.
One alarming trend highlighted by Moody’s Analytics is the proportion of commercial mortgage-backed securities (CMBS) loans that remained unpaid at maturity in 2023 across various sectors. Surprisingly, the office sector had the highest rate of loans that were not paid off at maturity, with 68.6 percent of CMBS loans remaining unpaid. This percentage even surpassed the struggling mall sector, where 41 percent of CMBS loans were not paid off at maturity.
Among the six property types examined—office, malls, non-mall retail, hotels, multifamily, and industrial—office was the only sector where the majority of loans failed to be paid off at maturity in 2023. This unsettling trend raises concerns about the office market’s ability to refinance these loans in the upcoming year.
Kevin Fagan, senior director and head of commercial real estate economic analysis at Moody’s Analytics, offered insights in the report into the factors influencing the likelihood of office loans being paid off at maturity. Notably, there is a strong correlation between loan size and repayment ability. Approximately 90 percent of office loans at $10 million or less were successfully paid off at maturity, while only 26 percent of loans at $100 million or higher were paid off. Smaller loans seem to have a better track record when it comes to repayment.
Moreover, loans backing office properties with low risk associated with major tenant turnover are more likely to be successfully refinanced. Companies that have longer-term leases or recently renewed agreements are more stable tenants and pose a lower risk of loan repayment. However, the continued trend of companies opting for smaller office spaces, consolidating their footprint, or moving into newer, more amenitized properties increases the risk of non-renewal, potentially impacting loan repayments.
Moody’s calculation of CMBS office loans paints a concerning picture, with an estimated 76 percent deemed at high risk of not being able to refinance in 2024. This assessment factored in variables such as lease rollover, the current status of the loan in special servicing, and the loan’s debt yield. This high-risk segment adds to the uncertainty surrounding the office market’s prospects in the coming year.
While many lenders have been working with borrowers to address issues surrounding maturing loans, including extensions and modified terms, the tightening of lending standards and the looming threat of a recession in 2024 may result in a higher rate of loan defaults and foreclosures on distressed properties. As Kevin Fagan puts it in the report, “The continued flow of these maturing loans that are running into trouble, particularly on the office side, are basically going to turn into delinquencies, and some will turn into losses.”
In addition to the challenges faced by the office sector, other property types are also grappling with losses attributable to higher capitalization rates, which are eroding returns and values across the entire commercial real estate market. Interest rate hikes are typically correlated with higher cap rates, contributing to the downward pressure on property values.
As we approach 2024, the office market and the broader commercial real estate sector must brace themselves for a challenging year. The uncertainties surrounding loan refinancing, coupled with rising interest rates and evolving market dynamics, will require stakeholders to adapt and innovate to weather the storm ahead.