The commercial real estate market is grappling with a new wave of distress, with office buildings leading the charge. In December, a record-breaking 11% of office buildings tied to commercial mortgage-backed securities (CMBS) loans were delinquent, surpassing the 10.7% peak set during the Great Recession in December 2012. This sobering data, reported by Trepp, marks a pivotal moment in the history of CMBS loans, which have been tracked since 2000.
More than $2 billion in office loans became newly delinquent in December, causing a staggering 63-basis-point jump in the overall CMBS delinquency rate. Over the past year, the office loan delinquency rate has nearly doubled, surging from 5.8% in December 2023 to its current 11%. This sector has emerged as the primary driver behind the broader rise in distress across the CMBS market, pushing the overall delinquency rate to 6.6%, up from 4.5% a year earlier.
A Perfect Storm for the Office Market
The office sector’s challenges are the result of a perfect storm of economic and societal shifts. The Federal Reserve’s aggressive interest rate hikes have pushed borrowing costs to levels not seen in decades, adding financial strain to property owners. At the same time, the rise of hybrid work models has cemented a trend of shrinking office footprints, leaving landlords grappling with soaring vacancies and falling demand.
“Looking closer at the CRE sector, loans secured by offices, especially those in major cities, remain the top concern,” the Federal Reserve noted in its November supervision and regulation report. The report highlighted that delinquency rates for commercial real estate loans have climbed to their highest levels since 2014, with late payments for office properties at large banks jumping by 11% in the second quarter of 2024.
The pain is particularly acute in major urban centers where older, Class B and C office buildings struggle to compete with newer, more amenity spaces. The shift to hybrid work has made tenants more selective, often opting for premium locations with modern layouts that support collaboration and flexibility. For landlords of outdated properties, the challenges of filling space have become nearly insurmountable.
Multifamily and Retail: Additional Headwinds in Commercial Real Estate
While the office sector remains the most beleaguered, it is not alone in facing difficulties. Multifamily borrowers, once considered a resilient segment of the market, are also under pressure. The delinquency rate for apartment properties rose from 2.7% at the end of 2023 to 4.6% in December 2024. Elevated interest rates have squeezed multifamily owners, especially those with variable-rate debt or properties in oversupplied markets.
Retail owners are similarly struggling. Delinquencies in the retail sector increased from 6.5% at the end of 2023 to 7.4% in December 2024. Brick-and-mortar retail has faced years of headwinds from e-commerce, but rising costs and changing consumer behaviors have added further pressure. Mall owners, in particular, continue to grapple with declining foot traffic and the need to repurpose vacant spaces.
Industrial: A Rare Bright Spot
Amid the broader challenges in commercial real estate, the industrial sector stands out as a rare bright spot. Delinquency rates for industrial properties fell from over half a percent to just 0.3% during the past year, according to Trepp. Strong demand for logistics and warehousing space, driven by the ongoing growth of e-commerce and reshoring of manufacturing, has buoyed this asset class.
Investors increasingly turn to industrial properties as a safe haven, lured by their consistent performance and robust tenant demand. Even as interest rates have risen, the fundamentals of the industrial market remain strong, offering a glimmer of hope in an otherwise troubled commercial real estate landscape.
What Lies Ahead?
The office market's challenges are unlikely to abate in the near term. With more than $20 billion in office CMBS loans maturing in 2025, landlords will face difficult decisions about refinancing, selling, or walking away from properties. Many older office buildings in major cities may be at risk of foreclosure or being repurposed, though conversions to other uses, such as residential, remain costly and complex.
In addition to market-driven factors, regulatory scrutiny is intensifying. Banks and financial institutions are tightening lending standards, making it harder for borrowers to refinance or restructure their loans. At the same time, policymakers are keeping a close eye on the ripple effects of rising delinquencies, particularly in large urban areas where distressed office properties could impact local economies.
Navigating the New Reality
For investors, understanding the shifting dynamics of the commercial real estate market is more critical than ever. Opportunities exist for those willing to take on risk, particularly in sectors like industrial or in properties that can be repositioned. However, navigating these waters requires a clear-eyed assessment of market trends, property fundamentals, and long-term demand drivers.
The commercial real estate market is at a crossroads. While the office sector faces historic challenges, the broader landscape offers a mix of risks and opportunities. By staying informed and adaptable, investors and stakeholders can position themselves to weather the storm and emerge stronger on the other side.
Comments