CMBS Disruptions in the Real Estate Market

The past few months saw, and continue to see, significant disruptions to the real estate market and the real estate finance market in particular. According to Trepp LLC, June saw the delinquency rate for commercial mortgage-backed security (CMBS) loans hit 10.32 percent, which is just shy of the peak delinquency rate for CMBS loans in 2012 (or a full four years following the 2007 – 2008 recession). That we could have nearly reached the 2012 peak so quickly—given the last time lag between a recession and peak delinquencies—has caused some investors to worry that much worse is yet to come. These numbers also cause certain investors to question whether CMBS disclosures may have been overly optimistic or failed to properly disclose risks. At the same time, regulated mortgage lenders, which must project losses, are assuming losses at approximately two percent on average.

Of course, the delinquency rates differ from asset class to asset class, with hotels and retail properties suffering most dramatically. Office properties, multifamily properties and especially logistics and warehouse facilities have remained relatively robust. Of course, the delinquency rate also differs from lender to lender, and borrower to borrower.

Note that the delinquency rate for CMBS loans fell from its June peak back below 10 percent according to 9.6 percent according to Trepp. Investors are also comforted that some high-profile companies continue to move ahead with major office leases.

This recent and slight reduction in the delinquency rate does not mean that the real estate finance market is on the path to recovery. Retail bankruptcies are likely to have a sustained effect on the market. Hotels will continue to need relief (or debt solutions) as travel remains impacted and office landlords will need to tackle a post-COVID-19 working environment and the changing need of tenants for traditional office space. Compounding these issues are a general uncertainty regarding the economy at large and the possibility of additional “pandemic waves.” We can reasonably expect—as the pandemic continues and the economic fallout from the pandemic continues to be felt—that significant real estate assets (including owned property or investments in property, mortgage or mezzanine loans and CMBS securities) will continue to be dramatically impacted.

Although there is hope that deferrals and other short-term strategies to wait out the pandemic may be enough to protect against losses, lenders and borrowers should gear up for bankruptcies, foreclosures, and other adversarial actions that are expected to come in the coming months.