Distressed Commercial Real Estate Is Still Sitting In Purgatory

It’s been obvious since the pandemic struck that commercial real estate would be hit hard.

The demand for office, retail, and hotel space has been crimped more or less permanently by Covid-19, which taught people to do many things online instead of in person. A worker whose skills are no longer needed can switch careers, but a building will always be just a building—a brick-and-mortar sitting duck. The surprise to date has been how few bankruptcies have occurred in commercial real estate. One reason for that is a slow fuse.

In February Bloomberg’s Allison McNeely wrote, “Troubled borrowers secured breaks of six to 18 months on their debt last spring as the pandemic shut off large parts of the economy and revenue dried up. But nearly a year later, some lenders are running out of patience and don’t have the ability to keep extending credit.”

Manus Clancy, a senior managing director at Trepp, a real estate data firm, told her, “We have tons of stuff that’s in purgatory”—not in hell, but not in the clear, either.

The unsettled question is what share of distressed properties will recover, and of those that don’t recover, how the losses will be distributed. A strengthening economy is both good and bad. It’s good in that it increases demand for leases but bad in that it puts upward pressure on building owners’ borrowing costs.

The Federal Reserve flagged commercial real estate as a trouble spot in February in its semiannual Monetary Policy Report to Congress. It said prices “appear susceptible to sharp declines” from historically high levels, which would be more likely to happen if the pace of distressed sales picks up or if the pandemic leads to longer-term declines in demand.

One sign of lenders’ confidence is that the ICE Bank of America index of fixed-rate commercial mortgage-backed securities, which began falling in March 2020, has since fully recovered. Another sign of health: On April 15, Real Capital Analytics Inc., which tracks dealmaking, reported that based on preliminary data for the first quarter, more U.S. commercial real estate was worked out of distress than became distressed. It was the first time that’s happened since the second quarter of 2019.

“We are not finished with all aspects of distress, however. There is a looming supply of potentially distressed loans that still may have an impact,” Jim Costello, a senior vice president at Real Capital Analytics, wrote.

Lots of loans are in forbearance, meaning that lenders are cutting borrowers some slack in hopes that conditions will improve and that they will eventually get their money back. Full recovery won’t always happen, though, especially in sectors that have become outmoded by Covid-induced changes in behavior.

“The challenge with so much of the potential distress is that all participants are taking a wait-and-see attitude,” Costello wrote.

Bottom line: A lot of commercial real estate is still in purgatory.


Source: Bloomberg