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Commercial Real Estate Loans Show Signs of Stress

Posted by Avatar Financial

Commercial Real Estate Loans Show Signs of Stress

Is this a temporary trend or ominous for the economy?

Since the financial crisis hit, the commercial real estate market has benefitted from approximately eight years of growth. However, data from Trepp, a company that tracks the performance of securitized mortgages, has shown that the delinquency rate on commercial real estate loans is increasing.

According to Trepp, roughly $2.4 billion in loans became delinquent in June and $1.4 billion in loans became delinquent in July. Trepp’s Commercial-Backed Mortgage Securities (CMBS) report for July 2017 stated that the delinquency rate is now 73 points higher than a year ago. In 8 out of the the past 11 months, the delinquency rate on commercial real estate loans has increased.

Among the different property sectors, the greatest downward movements from June to July were seen in the multifamily delinquency rate, which shed 101 basis points to 2.91%. As a result, the apartment sector was able to claim the title of best performing property type. An increase in delinquency rate was seen in July for the lodging sector, which climbed 15 basis points to 3.68%. The rate of loan delinquency has also risen in the office and retail sectors. In mid-2016, the rate of loan default in these sectors reached a post-crisis low of about 5% in mid-2016. Since then, the rate has been steadily climbing. It reached 5.75% this past June and 5.49% in July.

The Reasons Behind the Uptick in Delinquency Rates

Some of the uptick in delinquency rates can be attributed to the wave of maturities, with previously performing loans failing to be refinanced at their balloon date. This has added to the numerator of the delinquency equation. Additionally, there was a slow start to new issuance in 2017, which resulted in a decline of the total size of the CMBS industry, or denominator of the delinquency equation.

2016 and 2017 have been pivotal years for the refinancing of loans from the time of the financial crisis. There are many ten-year loans made in 2006 and 2007 that are now coming due and borrowers are struggling to pay them off. Another potential reason for the increase in delinquency rate could be that it is just the market correcting itself, which is what it tends to do every decade or two, as it did back in the 1990s as well as during the 2008 crisis.

Why Economists, Researchers, and Commercial Real Estate Analysts Are More Interested in Default Rates than Delinquency Rates

Delinquency rates are important to CMBS investors because they rely on timely bond payments, which are mostly driven by the largest loans in a deal. On the other hand, researchers, economists, and commercial real estate analysts tend to be more interested in default rates.

Default rates are based on aggregate loan balances, so a single large loan moving out of the pool can have a major effect, whereas small loans moving in or out of the pool have minimal effect. Default rates are derived by calculating the number of new defaults in a given period as a percentage of the whole CMBS industry. The percentage is based on loan count, not loan balance, so small and large loans have the same effect on the default rate. Due to the high volume of loan maturities in 2017, the default rates have been creeping above recession-era levels. A default is considered to be any loan that has been delinquent for 90 days or more.

With commercial real estate prices at an all-time high, frequent talk of the wall of maturities, and a favorable economy, it’s easy to ignore the rising default and delinquency rates. Nevertheless, the uptick is interesting and something worth watching in the coming months.

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Avatar Financial is a direct lender offering commercial hard money bridge loans for nonconforming, income-producing real estate nationwide. We offer quick turnaround on loans between $1 and $10 million in urban and suburban markets with populations of 250,000+. For more information, contact us today.

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