Office-loan delinquencies hit 5-year high in 2023 and likely will rise even higher, Moody’s says

The CMBS market is where Wall Street lenders package up debt on office buildings, hotels, shopping malls and other property types into bond deals that are sold to investors.

Delinquencies in the sector are expected to increase in the coming months for borrowers who financed properties at low rates but now face higher borrowing costs on a wave of maturing debt, said Darrell Wheeler, head of CMBS research at Moodys.

“It’s not just office,” Wheeler told MarketWatch on Wednesday. He pegged about $3 billion of maturing CMBS loans on different property types that were financed in the past decade that Moody’s thinks could be a challenge to refinance.

See: ‘No one is throwing good money after bad.’ Why 2024 looks like trouble for commercial real estate.

A big part of the puzzle will be what the Federal Reserve does with interest rates, and how well the U.S. economy holds up, said Wheeler, a veteran of the commercial real-estate market since the 1990s.

“The recent rally in Treasurys may cause some people to lock-in rates,” he said. “But it’s still a very uncertain market for the borrower. We’ve never seen Treasury volatility like this before.”

The 10-year Treasury yield
BX:TMUBMUSD10Y
hit 5% in October, but swiftly retreated in the following weeks on hopes that the Fed would start cutting rates in 2024. The benchmark rate is used as a financing peg for the commercial real-estate market and the broader U.S. economy.

Despite extreme volatility in rates last year, the 10-year started the new year roughly where it began in 2023, and was trading near a 3.905% yield on Wednesday.

Minutes of the Federal Reserve’s mid-December meeting released on Wednesday showed U.S. central bankers didn’t rule out further interest-rate hikes.

Stocks rallied at the tail end of 2023, with the Dow Jones Industrial Average
DJIA
setting a series of record closes and the S&P 500 index
SPX
trading near its record high. Stocks ended lower Wednesday.

Last summer, the Fed raised its policy rate to a range between 5.25% and 5.5%, and has kept it there at recent policy meetings. Higher borrowing costs have been a major point of stress for property owners, even though higher rates also have helped get inflation down from a 9.1% peak, without yet throwing the U.S. economy into a recession.

While hotels, multifamily and industrial properties have benefited from a strong labor market, revenue has sharply fallen in the office sector, according to Moody’s data.

Wheeler said the current disconnect between employment and potential office revenues suggest that hybrid work had reduced office demand by 14.5% on a national basis. 

Many tenants also are expected to seek to renew rolling office leases at lower rates, and for less space. A recession, while now viewed as less likely in 2024, also would likely add to office woes.

There also is the roughly $1.2 trillion wall of U.S. commercial property debt due to mature through 2025, according to the Mortgage Bankers Association. The CMBS market is only a part of the larger lending market.

With the tough backdrop, regulators in December said commercial real estate was a top threat to the financial system in 2024.

Still, Wheeler expects overall CMBS loan delinquencies, pegged at 4.87% in November by Moody’s, to stop short of 6% in 2024.