Manus Clancy is head of data strategy at LightBox
One of the big commercial real estate (CRE) headlines in May came from the fact that a big CMBS loan was resolved with a loss that included a write down of part of the AAA-rated class. The loss was the first of its kind since the Global Financial Crisis (GFC) and came with warnings that the end is near for CRE. (Among the many social media comments was that it was time to short CRE…more on that in a future research piece).
While the national headlines paint a bleak picture for CRE, the reality is much more nuanced and there have been some hopeful signs in recent weeks.
To be sure, there is no doubt that values across all the major CRE property types remain lower than they were in early 2022. For some property types— like office— the value drop remains yawning. However, for many other property types— retail, hotels, and industrial— the value drops are simply a function of higher cap rates…not oversupply, lack of demand, or any other post-COVID impact.
The Picture is Rosier Than Past Downturns
In a recent talk at the Lightbox PRISM conference in Dallas, we noted that the CRE downturn of 2022-2024 has many differences between the 1990 and 2008 CRE crises.
For one, in 1990 and 2008, bank failures were plentiful, and liquidity was completely absent. In each case, there was almost no lending for two years or more and no property type was immune from distress and value destruction.
Fast forward to 2024 and we have a vastly different picture. Distress in industrial, retail, and hotels has moved up only modestly over the last two years. In the multifamily space, while distress is up considerably, a significant portion of the defaults come via a huge “unforced error” by apartment buyers; the use of short-term floating rate debt to finance the purchases.
Yes, distress in the office sector is extensive and deep, but that remains an outlier compared to the other four property types.
Differences between 1990 and 2008 are also underscored by the fact that lending to CRE never fully turned off over the last two years. Certainly, lending is down over the last 24 months, but the spigot never fully turned off like it did during past crises.
None of this is to suggest that the last two years haven’t been desultory—they have been. It’s only to make the point that the sicker the patient, the longer the recovery. The CRE market in 2023 was not as sick as the patient in 1990 and 2008. Hopefully, that means the recovery in 2024 comes faster than in those earlier periods.
Hopeful Signs
As noted, for those just watching CNBC or reading the Wall Street Journal, one would think the CRE apocalypse is here. The truth is rarely as simple as headlines suggest.
For those looking for hopeful signs, here are several:
Velocity of Transactions Up
The LightBox research team tracks monthly the movements of CRE activity across a number of LightBox platforms that include appraisals, environmental due diligence, and commercial property listings creating a barometer of broad industry shifts in response to changes in market conditions.
Together, the velocity of transactions showed a moderate bump in the Q1 2024 LightBox Activity Index and another healthy bounce in April 2024. These upticks reinforced anecdotal remarks made at the LightBox PRISM User Conference by lenders, appraisers, and environmental engineers that transactions were starting to pick up.
Loan Sales Provide Proof of a Thaw
In May, we also saw some sizable loan sales—another indicator that liquidity is available and evidence that the markets are not “frozen.” Most notable was a $2.9 billion purchase of 2,000 CRE loans by Bank of America from Washington Federal. The sale represented a purchase price of about 90 cents to par, according to the Charlotte Business Journal. Overseas, Blackstone paid $1 billion for performing CRE loans from Deutsche Pfandbriefbank. Those stories come on the heels of others like Goldman Sachs and Blue Owl Capital looking to deploy capital into CRE, and in Blue Owl’s case, buy loans.
Sizeable Transactions Across Segments
On the sales front, sizable transactions across several segments were reported in May.
In the hotel segment, the Arizona Biltmore traded for more than $700 million (about $1 million per key) and a two-property hotel package in Nashville sold for north of $500 million (more than $730,000 per key and a 7.4% cap rate according to HotelManagement.net). Other nine-digit hotel sales took place in San Antonio and La Jolla.
Other sizable sales were seen in the industrial, student housing, and apartment segments.
In the beleaguered office market, sales (at sizable discounts to prior prices) were reported in Washington D.C., San Francisco, and Boston.
At the risk of being redundant, these sales are evidence that the markets are functioning, albeit still at a significantly slower pace than in 2021 and early 2022.
Some Caution Still Warranted
While momentum seems to be picking up for the CRE markets, it is still too early to say the market is out of the woods.
On the Fed front, there has been enough positive economic data that most analysts now believe that two or few rate cuts – even no rate cuts – is the likely outcome for the remainder of the year.
Separately, the yields on late-dated Treasuries remain problematic. The yield on the 10-year period ended April at 4.69%. After falling to as low as 4.36% in mid-May, the rate climbed back up above 4.60% in late May.
The takeaway is that borrowers are not likely to see any relief on interest rates in the near term. Accordingly, future gains in CRE markets will likely continue to be measured, not eye-popping— just as they have been thus far in 2024.
For now, CRE investors and lenders should try to look beyond the ongoing apocalyptic headlines and take comfort in the modest pickup in sales activity and the fact that other than office, the sky isn’t falling in CRE.
