- Fixed Income Credit Analyst
- About Us
- My Account
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
Tough times have gotten even tougher for the commercial real estate (CRE) sector over the past month or so, starting with the well-publicized failure of Silicon Valley Bank (SVB) on March 10, 2023 — but not all areas of CRE are equally vulnerable to today’s stresses, so finding potential investment opportunities is all about knowing where to look.
As of this writing, we have become more negative on the broad outlook for commercial mortgage-backed securities (CMBS) based on tightening credit conditions at regional US banks. Going into March, CRE was already facing stiff headwinds from substantially increased borrowing costs, declining asset values, and a generally slowing economy. The recent turmoil in the banking sector has only exacerbated these challenges, especially for weaker commercial properties.
Regional banks have historically been among the largest providers of CRE financing, accounting for as much as 70% of such lending by all banks, which equates to nearly 30% of total CRE debt financing. Shrinking credit availability from these regional banks will of course further restrict borrowers’ access to needed capital, making it more difficult to refinance a CRE loan and likely adding to downward momentum in property prices.
At this juncture, we are most negative on office buildings and regional malls — two commercial property groups that were already under tremendous secular pressures and are among the main components of a diversified CMBS pool. We still expect the grim story in the office segment to play out over several years due to the many long-term leases that are currently in place, although we are closely monitoring lease rolls given that vacancy levels are now higher than they were during the global financial crisis (GFC), including for subleased office space.
Similar to previous downturns in the CRE sector (notably, during the GFC and amid COVID-19), we expect loan special servicers to grant loan modifications and extensions to troubled borrowers as long as the latter can demonstrate a willingness to work with the servicers. Still, deal sponsors will likely need to contribute their own capital to help support underperforming assets, which may cause many of them to walk away from the properties (as we have seen with a few high-profile office loan defaults recently).
The special servicer “playbook” was successful during the GFC and COVID-19 because the CRE sector downturns were temporary. The risk case this time around is that the slump could prove deeper and more lasting for the office segment (similar to what we saw in retail), leaving many borrowers reticent to pony up fresh capital. On the positive side, loan maturities have typically been a catalyst for an uptick in defaults, and there is fortunately not a large number of loans scheduled to mature this year.
We believe borrowers who locked in cheap fixed-rate financing at low interest rates will be incentivized to extend their loans in order to buy time for borrowing costs to come down and lending conditions to improve. Borrowers who took out floating-rate loans, however, are already grappling with “payment shock” from higher rates and may thus be hard-pressed to meet the performance hurdles required to extend their loans (e.g., debt-service coverage ratios). Additionally, these borrowers would have to purchase new interest-rate caps for an extended loan period, which have become quite expensive following the sharp rise in rates over the past year or so. These factors could explain why some floating-rate borrowers are opting to walk away from their properties.
Overall, we expect CMBS performance to vary considerably by property type and submarket in the period ahead:
ICE Data, its affiliates and their respective third-party suppliers disclaim any and all warranties and representations, express and/or implied, including any warranties of merchantability or fitness for a particular purpose or use, including the indices, index data and any data included in, related to, or derived therefrom. Neither ICE Data, its affiliates nor their respective third-party suppliers shall be subject to any damages or liability with respect to the adequacy, accuracy, timeliness or completeness of the indices or the index data or any component thereof, and the indices and index data and all components thereof are provided on an “as is” basis and your use is at your own risk. ICE Data, its affiliates and their respective third-party suppliers do not sponsor, endorse, or recommend Wellington Management Company LLP, or any of its products or services.
The “cleanest dirty shirt” now has too many stainsContinue reading
Public CRE debt — Risk, opportunity, or both?Continue reading
Commercial property values shrinking? No problem for big citiesContinue reading
Why cash won’t cut it for long: The case for bondsContinue reading
US loses its AAA rating (again)Continue reading
The “cleanest dirty shirt” now has too many stains
Fixed Income Portfolio Manager posits that US fiscal profligacy will change the game for asset allocators.
Public CRE debt — Risk, opportunity, or both?
Our experts explore the implications of the ongoing stress in the public CRE debt, or commercial mortgage-backed securities (CMBS), space for investors and analyze risks and opportunities for ratings-constrained insurers.
Commercial property values shrinking? No problem for big cities
We analyze the impact of declining office property values and outline the reasons why they believe large cities should be able to weather the storm of shrinking commercial property value.
Why cash won’t cut it for long: The case for bonds
Global Investment and Multi-Asset Strategist Nanette Abuhoff Jacobson and Investment Strategy Analyst Patrick Wattiau explore the relative potential benefits of bonds versus cash.
US loses its AAA rating (again)
US Macro Strategist Michael Medeiros analyzes Fitch's recent downgrade of US credit quality and explores the bigger issues at play.
Bank loans remain attractive despite macroeconomic uncertainty
Our experts believe that bank loans currently offer attractive levels of income and have already priced in an overly bearish macroeconomic view.
Evaluating labelled bonds: a robust framework is key
Fixed Income Portfolio Manager Campe Goodman and Investment Specialist Will Prentis explain why they believe a robust framework for analysing labelled, or sustainable, debt can help to generate real-world impact.
State of the credit markets: Does cash rule everything around us?
Fixed Income Portfolio Manager Brij Khurana outlines the state of the credit market today, compares historical periods of quantitative easing, and warns credit investors of cash scarcity in the near future.
FX outlook: Is USD exceptionalism withering away with the Fed hiking cycle nearing an end?
Discover the status of the USD today, learn where the greenback may be headed going forward, and understand why.
Credit market outlook: Expect greater opportunities in back half of 2023
Against a backdrop of elevated recession risks and banking-sector stress, Fixed Income Portfolio Manager Rob Burn identifies relative-value sector opportunities in the credit market.
Fixed income 2023: Will opportunity keep knocking in the second half?
Learn where Fixed Income Strategist Amar Reganti sees opportunities in the fixed income market today and dive deeper into the three key themes he thinks investors should consider going forward.