Cloud hangs over commercial real estate as trillions in debt set to come due

Commercial real estate is facing a mountain of debt that many borrowers could have trouble refinancing due to a rapid hike in interest rates and record vacancies, according to The Wall Street Journal.

Around $2.81 trillion in commercial real estate loans are set to expire through 2028, meaning borrowers would either have to pay the amount outright or refinance the debt with higher interest rates, according to data from market research group Trepp. Payments on commercial mortgages are typically only for interest while the loan is active, and when the loan reaches its expiration date, borrowers often refinance at current rates, but doing so would increase payments drastically in a time when commercial developers and property owners are strapped for cash, according to the WSJ.

“Borrowers have simply been unwilling to accept reality,” Gwen Roush, senior vice president of DBRS Morningstar, told the WSJ. “But reality has to come due at some point.”

Around $544.3 billion in commercial real estate loans came due in 2023, the largest amount ever, which is expected to only increase in the next few years, according to Trepp.

Most commercial real estate loans that are coming due were acquired and fixed when interest rates were far lower, meaning any refinancing would substantially increase the costs of holding that debt, according to the WSJ. Additionally, rising vacancies in the sector, particularly for office space, due to more businesses allowing workers to operate from home have decreased many property owners’ cash flow as they struggle to sell or rent office space.

The Bill Is Coming Due on a Record Amount of Commercial Real Estate Debt https://t.co/GAShKAyOAU pic.twitter.com/rpOXFC1ofI

— Jesse Felder (@jessefelder) January 17, 2024

Interest rates in commercial real estate are being swollen from hikes by the Federal Reserve to the federal funds rate, which is currently sitting in a range of 5.25% and 5.50%, the highest rate in 22 years after a series of hikes starting in March 2022 meant to combat high inflation. Borrowers could get some relief in the coming year from cuts to the federal funds rate, with a median of Fed governors projecting the rate to end the year at 4.6%.

Commercial mortgage-backed security delinquencies are projected to rise in the coming years as more loans come due, according to Fitch Ratings. The rate of delinquencies is expected to reach 4.5% in 2024 and then climb further to 4.9% in 2025, up from just 2.25% in November 2023.

Small and mid-sized banks, those outside the top 25 in terms of assets, held around 67.2% of all commercial real estate loans in March 2023 but only owned around 37.6% of total loans, making bankruptcies in commercial real estate a particular threat to those banks. Small and mid-sized banks are still reeling from a crisis that hit the sector in early 2023, leading many depositors to flee to bigger banks where they feel their money is safer from bank runs and resulting shutdowns.

Some developers and property firms have already fallen victim to the debt crisis in the sector, including mortgage real estate investment trust JER Investors, which filed for bankruptcy in December. WeWork, a start-up offering flexible workspace for rent that was once valued at $47 billion, filed for bankruptcy in November.

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