Pulse on commercial real estate

Pulse on commercial real estate

BlackRock’s Financial and Strategic Investors Group (FSIG) hosted a webcast to discuss the market impact we have seen in commercial real estate amidst heightened market volatility and the outlook for this sector. Watch the replay.

Key points


A confluence of challenges

Commercial Real Estate is as an asset class facing a confluence of challenges: much higher interest rates, large refinancing needs, lower bank lending and investor demand, and cashflow headwinds linked to societal changes.


A slow deterioration

Our view is these challenges should lead to higher risk premia and, in the weaker parts of the market, more defaults and downgrades. However, this deterioration will take years to play out. These dynamics are particularly strong in the US, but also present to a lesser degree and with lags in Europe and across other geographies.


Strong return opportunities

In the current market environment, strong return opportunities are being generated for the end investor with capital to deploy, particularly in higher-quality segments of the market.


Macro headwinds

Little sensitivity of economies to the sharp moves in policy rates and decline in central banks’ balance sheets means that the Fed and other central banks might need to maintain restrictive policy rates for longer than what the market is currently pricing. This will bring challenges to areas of the market that have the most leverage, that are exposed to the front end of the yield curve that has moved the most, i.e., floating rate borrowers, or those that are having to refinance loans from many years ago.

Our view is the stress we’re seeing across commercial real estate is not specific to the asset class, but the combination of macro factors with the secular challenges and changes that have taken place across the industry going back 10 years.

National CRE property prices declined by -7.1% YoY in March 2023

Secular shifts

We have seen large secular shifts in favor of industrial portfolios and e-commerce. Multifamily properties benefit from a housing shortage and home ownership affordability issues. COVID exacerbated challenges for office, retail, and hospitality, the latter which has come back strongly.

COVID accelerated this secular trend, leading to elevated positive net absorption
Structural housing shortage provides a tailwind for multifamily properties

We expect to see stresses in the office market continue as a challenge for many CBDs across the U.S. The structural headwinds to the office segment will be offset by longer lease structures that will allow for longer financing periods for borrowers. For Europe, these structural headwinds are less prevalent as they have much closer proximity of transportation to most major cities and offices than the U.S.

A lot of financing that took place over the last decade was for properties that are no longer providing as much cash flow as initially anticipated. Moreover, many of the loans that were taken out in 2020 and 2021 saw large shift to floating rate borrowing with heightened leverage due to easy financial conditions.

Office Occupancy is about half of pre-COVID levels
Positive office rent growth unlikely to continue due to secular and economic trends

Over the last decade, we saw institutional capital coming from around the globe into trophy assets in major cities because of low interest rates abroad. For instance, rather than invest in negative yields in other developed markets, international investors entered the New York City office property in search of cash flow and some additional yield. As yields continue to move higher globally, we would expect there to be some continued adjustment from the end buyer’s perspective related to diversifying asset allocations, and a corresponding adjustment to cap rates.

Regional bank stress

Regional banks are a meaningful lender to commercial real estate, accounting for about 38% of CRE debt lending on income-producing assets, and even higher if looking at construction and owner-occupied properties. To put the recent market stresses into perspective, looking at the income-producing commercial real estate loans held by small banks and assuming significant contraction in the market, we would still expect absorption to be manageable.

Our view is the excess capacity caused by regional bank stresses can be more easily absorbed by the market versus prior cycles through institutional dry powder, healthy capital markets, and a more robust securitization market that can take some of the market share. Amidst higher costs of capital and an overall contraction, security selection across markets and property types will be instrumental in deciding the winners and losers.

Pull back in bank balance sheet capacity will impact credit supply and CRE valuations
CRE Disclosures by Banks

In Europe, the landscape is different in that generally, for some jurisdictions, there is a bit more concentration amongst larger lenders in the sector compared to the U.S. The European CMBS market is also much smaller as a percentage of the commercial real estate market. From what has been reported by banks thus far, the percentage of commercial real estate loans as a percentage of total loans on balance sheets is less concentrated1. In the U.K., banks have generally been decreasing the amount of commercial real estate exposure since the last financial crisis. Impairment levels today from CRE loans across banks are still generally low. We continue to keep a close look on delinquency rates as loans start to mature and poorer quality assets may run into refinancing trouble and face extension risk.

The assets that are maturing in the near term are going to face the greatest challenge given the tightening lending standards, peaking Fed funds rates, and higher credit risk premiums in the market. There’s over $1 trillion coming due through the end of 20242, which will force a reality check on some of the fundamental issues at play, specifically for some of the smaller balance loans.

Expect a lot of extensions similar to GFC
Extension Length can vary from under 6 months to more than 5 years, expect 2-3 years on average

Our base case scenarios

We expect to see a lot of maturity extensions, or real cash required by sponsors to refinance debt. For assets with strong short- to medium-term fundamentals, the story will be centered around accommodating the financing cost and resetting valuations to grow rents. Office remains our biggest concern, we are focused on the different subsectors and submarkets and are factoring in bifurcation between trophy assets and the broader market as well as financing flexibility from sponsors.

We see higher risk premium across all property types and classes, but there’s a clear differentiation between deals that have exposure to office and those that do not. Though delinquencies remain in low single digits, we would expect this figure to pick up as we approach maturities. Our view is that pain is going to be spread out over a number of years and it will take time for the market to digest the effects, helping investors better evaluate the differences across underlying collateral.

We’ve seen very limited ratings migration post 2009. Across AAAs, less than a percent of the universe has been downgraded, AAs, about 6%, going all the way down to BBB, about 20%. Credit support levels are much stronger than pre-GFC, 1.5x to 2.5x as much as what we have seen historically and LTVs on average have dropped from 70-80% to 55-60%. Our view is the extra credit support, conservative underwriting, and learning experiences that came out of GFC have improved the quality of loans that are now in CMBS, all of which will help weather the storm for downgrades. Rating agencies tend to also be reactive in taking actions to appraisals, changes in cashflow profiles through maturity defaults, tenancy bankruptcies, etc. We thus expect a slow and prolonged rating downgrades across the market, over the course of the next 5 or 10 years, with pressures specifically below the AAA level.

Rating Transitions for CMBS – Post 2009

Q1’ 23 transaction volumes are down almost 60% year on year3 and thus bid-ask spreads remain wide. Given the bid offer gap, we’re not seeing as many transactions occur. Forced selling has also not been a factor, even the dispositions via the FDIC on securities coming from SVB and Signature Bank’s balance sheets are predominantly across agency CMBS, a very different part of the market than the credit securities where we are seeing challenged pricing.

Overall, we remain constructive on CMBS and view current levels as attractive, with yields of 5% at the top of the capital structure, increasing by hundreds of basis points if you pick the correct spots as you go down in quality. We continue to prefer rotations into assets where we see a stable coupon and stable rating versus potentially distressed levels. Across the secondary market, dispositions for reasons which are not economic in nature should provide good opportunities in the coming months.

Featured speakers

Mark Erickson
Global Head of Financial Institutions Group
Isabelle Mateos y Lago
Global Head of Official Institutions Group & Chief Markets Strategist for the Financial and Strategic Investors Group
Dan Garzarella
Head of U.S. Total Return and Global Head of Structured Products for the Financial Institutions Group
Samir Lakhani
Co-Head of Securitized Assets
Eugene Chan
Director - Securitized Assets

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