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- Distress in a corner of the commercial mortgage market rose 440% in the last year.
- Loans packaged into commercial real estate CLOs saw a big uptick in distress.
- Multifamily and office borrowers accounted for the brunt of the distress.
Distress levels in an important corner of the commercial real estate debt market have rocketed higher in the last year.
Commercial mortgages packaged into collateralized loan obligations and sold to investors as bonds saw a distress rate of 8.6% in January, marking a huge jump from the beginning of 2023 when the rate was 1.4%. The amount of outstanding loans packaged into CLOs is about $80 billion, according to a report by data and analytics firm CRED iQ.
By dollar amount, loans that experienced some level of distress grew from $1.3 billion in February of 2023 to $6.8 billion last month, rising about 440%, CRED iQ said.
The data firm defines distress as loans that are 30 days or more late on making a payment.
Commercial property loans that get packaged into CRE CLOs are primarily short-term, floating-rate mortgages backed by buildings in need of some updating or further investment. The loans are typically three-year loans with the option to extend, and many borrowers aim to refinance with cheaper fixed-rate debt.
Major CLO issuers are vulnerable to losses if borrowers default. Many of the loans were originated in 2021 when rates had not yet risen. Three years later, as the Federal Reserve's rate cut timelines continue to get pushed out, commercial property owners are faced with refinancing at higher interest rates and possibly lower property valuations.
Multifamily and office building borrowers bore the brunt of the distress among loans packaged into CRE CLOs, according to CRED iQ.
The office sector in particular is facing big problems as remote work trends persist with no apparent turnaround in sight. Meanwhile, concerns ar mount over a looming surge in commercial real estate debt, estimated at nearly $1.5 trillion in the coming years.