Commercial Real Estate: When Maturity Means Default

This Commercial Real Estate sector report is excerpted from the First Quarter 2024 Fixed-Income Sector Views.

Nearly $1.2 trillion of commercial mortgage loans will mature in 2024–2025. Office loans make up over 17 percent of those maturities, according to the Mortgage Bankers Association. With few lenders making new office loans, we anticipate that the existing mortgage lenders will be forced to either extend maturity or declare the loans in default. Some borrowers whose loans are underwater may simply hand over the keys at maturity. This maturity wall will create stress for smaller commercial banks in particular. Of the commercial real estate exposure held by banks, Green Street estimates that 75 percent of the loans are held by local and regional banks with less than $250 billion in deposits. This stress is coming at a time when these same banks have struggled to retain deposits and have experienced increased funding costs,, so they have less room to absorb losses from maturing loans.

We have already seen this happening. From July to September 2023, only about 10 percent of maturing office CMBS loans paid off at maturity on original terms, according to Moody’s. Although the percentage improved at the end of the year with Treasury rates moderating in the fourth quarter, there is limited capital available to refinance maturing loans, especially in the office sector.

Several factors are contributing to this stressed situation. The carry cost of mortgage debt has increased materially, with current mortgage rates two to three times higher than they were when the loans were originated. At the same time, the post-pandemic decline in demand for office space is putting downward pressure on rents and property values. Operating costs, particularly insurance costs, have increased significantly. Lenders that are willing to make a mortgage loan secured by an office property today are underwriting to very conservative standards. To achieve a mortgage refinancing, borrowers may be required to contribute fresh equity, which some are unwilling to do when current property values demonstrate that the loan may be underwater.

During the Global Financial Crisis, lenders were able to limit losses from maturing loans by simply extending maturities to bridge the loans into a more favorable refinance climate. With the reset in property values that we are seeing in the office sector, buying time in the current market may not be enough to avoid losses on maturing office loans. In an environment like this, commercial real estate investors and lenders must be extremely vigilant in assessing their existing portfolios and run draconian stress tests before committing new capital. This highly illiquid environment, however, may create opportunistic buying opportunities for savvy investors willing to take a long-term view.

—By Jennifer A. Marler and Farris Hughes

Important Notices and Disclosures

This material is distributed or presented for informational or educational purposes only and should not be considered a recommendation of any particular security, strategy or investment product, or as investing advice of any kind. This material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. The content contained herein is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation.

This material contains opinions of the authors, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward-looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

Investing involves risk, including the possible loss of principal. In general, the value of a fixed-income security falls when interest rates rise and rises when interest rates fall. Longer term bonds are more sensitive to interest rate changes and subject to greater volatility than those with shorter maturities. During periods of declining rates, the interest rates on floating rate securities generally reset downward and their value is unlikely to rise to the same extent as comparable fixed rate securities. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Investors in asset-backed securities, including mortgage-backed securities and collateralized loan obligations (“CLOs”), generally receive payments that are part interest and part return of principal. These payments may vary based on the rate loans are repaid. Some asset-backed securities may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity and valuation risk. CLOs bear similar risks to investing in loans directly, such as credit, interest rate, counterparty, prepayment, liquidity, and valuation risks. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate.

Guggenheim Investments represents the following affiliated investment management businesses: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Partners Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, and GS GAMMA Advisors, LLC.

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