Posthaste: Brace for more pain in commercial real estate as a mountain of debt comes due – Regina Leader Post

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The rapid rise in interest rates has been hard on commercial real estate, especially the office sector, already staggering under the blows of the pandemic.

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Now a new threat looms as hundreds of billions of dollars in loans reaches maturity over the next few years, says a new report from TD Economics.

Make no mistake, this is not just the United States’ problem. Troubles in the U.S. CRE market that hit lenders in recent weeks such as New York Community Bancorp have spread to Japan and Europe, raising fears about broader contagion.

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Shares in German lender Deutsche Pfandbriefbank AG fell to a record low today after it was downgraded by S&P Global Ratings over its high exposure to the U.S. commercial property market. The German company has described the current turmoil as the “greatest real estate crisis since the financial crisis.”

An estimated US$540 billion in commercial real estate loans in the United States will come due this year and another US$535 billion next, says the report by Toronto Dominion economist Admir Kolaj.

Meanwhile, market fundamentals are deteriorating fast, with offices the most vulnerable sector.

Office properties have been struggling since the pandemic ignited the work-from-home movement. Even though employers are increasingly pushing to get their workers back to the office, remote work days still remain high at 30 per cent, far above the 5 to 7 per cent before the pandemic, said Kolaj.

Companies might not get rid of their offices entirely, but they are downsizing when leases expire. CoStar estimates that office tenants gave back about 65 million square feet of space last year.

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Office vacancy rates are rising, rents are stalled and the expected economic slowdown and drop in hiring in the United States will only deepen the slump, said Kolaj.

“It appears that the deck is stacked against office fundamentals for the time being, with the office vacancy rate likely to continue trending higher this year, and rent growth to dip into negative territory once again, something that is sure to weigh on net operating income,” he said.

Commercial-property prices are down 21 per cent from a peak reached in early 2022, Bloomberg reports, with office prices falling 35 per cent.

The TD report cites research that says 44 per cent of office loans appear to be in negative equity, where the current property value is less than the loan balance.

With property values down and interest rates higher, many owners whose loans mature will need to come up with more capital to maintain an adequate loan-to-value ratio, said Kolaj.  But finding that money won’t be easy or cheap.

The alternative is selling in a soft market or handing the keys to the lender, he said.

“Together with property values that have retreated from their pandemic highs, and a large amount of loans coming up for maturity in a higher interest rates environment, these elements suggests that we should brace for more distress in the CRE space ahead,” Kolaj said.

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Property owners will get some relief when the Federal Reserve begins to cut interest rates, likely by mid-year.

“Still, it remains to be seen to what extent this would limit the fallout, or if the pullback in rates will be ‘too little, too late’,” the report said.

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Today’s Posthaste was written by Pamela Heaven with additional reporting from Financial Post staff, The Canadian Press and Bloomberg.

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