The commercial mortgage-backed securities (CMBS) market has remained resilient amid the pandemic. After an initial surge in delinquent loans, the delinquency rate has fallen in 22 of the last 23 months. Strong underlying fundamentals, property price appreciation and favorable lending markets have been supportive of commercial real estate. The overall credit picture continues to demonstrate improvement this year, despite negative headlines surrounding geopolitical risk, rising interest rates and persistent inflation.
This week’s chart highlights the most recent watchlist, special servicing and delinquency rates by property type in the non-agency CMBS market. These are measures that can indicate the overall health of existing CMBS loans. The market experienced a spike in delinquencies immediately following the onset of the pandemic, led by hotel and retail properties that bore the brunt of the lockdown. The delinquency rate hit 10.32% in June 2020 amid the related volatility. This was near the all-time high of 10.34% recorded in July 2012. Many loans were granted some form of forbearance due to the pandemic, which has contributed to the decline in the delinquency rate as loans were brought current.
In other positive trends, the overall special servicing rate has fallen to 5.12% in May, down from 8.65% one year ago. Lodging properties have experienced the most significant decline during the past year, reporting 8.42% this past month while the rate was 20.11% in May 2021. The overall decline in distress loans indicates that many loans have cured and the market has not experienced significant losses to the trust. The overall delinquency rate also continues to improve, down 143 basis points (bps) year-to-date and 302 bps year-over-year.
However, most CMBS property types are experiencing elevated levels of loans on the servicer’s watchlist. The overall watchlist rate for CMBS loans was 22.4% in May 2022, only down slightly from 23.6% at the beginning of the year. While hotel loans have experienced an improvement in delinquency trends, as a result of improved occupancy rates and property price appreciation, over 50% of all outstanding CMBS loans for lodging currently remain on watchlist. Likewise, watchlist rates for retail (21.1%), multifamily (19.8%) and office (18.1%) properties remain high.
Watchlist loans can arise for a variety of reasons, including but not limited to a decline in vacancies, decreasing cash flow to the property, declining debt-service coverage ratio, impending loan maturity, upcoming lease renewals, delinquent tax payments, property damage, tenant bankruptcy and loan modifications. Watchlist loans could have difficulty refinancing, especially those already struggling prior to the pandemic. Rapidly rising rates and slowing property price appreciation could present heightened refinance risks to troubled loans. This may result in more maturity defaults and loan extensions.
On the positive front, distress rates continue to decline despite recent volatility in the stock market. The U.S. commercial real estate sector also continues to perform very well, with continued demand from investors. However, today’s macroeconomic environment has created some new sources of stress for investors. Much uncertainty remains, as higher interest rates along with a potential economic downturn will most likely put additional stress on loans.
Given several market headwinds, the recent strong performance of the commercial real estate market may be unsustainable. I would expect commercial real estate property price appreciation to slow or flatten out for the remainder of the year, while inflation will have an impact on property performance. I continue to maintain an up-in-quality bias as some uncertainty remains and the outlook has turned less optimistic.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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