Commercial mortgage-backed securities (CMBS) delinquency rates are soaring, hitting 10.4% in November 2024, as the office sector grapples with unprecedented distress.
The office sector of commercial real estate is facing significant distress, with the delinquency rate for office mortgages securitized into commercial mortgage-backed securities (CMBS) surging to 10.4% in November 2024, just below the 10.7% peak during the Financial Crisis. This marks the fastest two-year spike in delinquency rates on record, with an 8.8 percentage point increase over the past two years. The shift to remote work has drastically reduced demand for traditional office space, leading to increased vacancy rates and higher delinquency rates, with office properties accounting for 60% of newly delinquent loans in October 2024. As you explore further, you'll find detailed insights into how these trends are impacting property values and potential market adjustments.
The delinquency rate for office properties in commercial mortgage-backed securities (CMBS) has been on a steep ascent, driven by significant increases over the past few months. As of November 2024, the delinquency rate for office CMBS has surged to 10.4%, just below the peak of 10.7% seen during the worst months of the Financial Crisis.
This rapid escalation is the fastest two-year spike ever recorded, with the delinquency rate increasing by 8.8 percentage points over the past two years. This is far surpassing the 6.3 percentage point increase observed during the two years through November 2010, a period marked by significant financial turmoil.
The rise in delinquencies is largely attributed to the ongoing trend of remote and flexible work arrangements, which has led to a significant oversupply of office space. This shift has adversely affected investor sentiment and highlighted the need for stricter lending standards to mitigate future risks. According to Trepp's data, office properties made up 60% of newly delinquent loans in October, with the office sector's special servicing rate jumping to 13.94% from 9.74% at the beginning of 2024.
These statistics underscore the pressing need for market adjustments, such as repurposing vacant office spaces, to alleviate the financial strains on investors and the broader commercial mortgage market.
Remote work trends have drastically altered the landscape of office spaces, contributing greatly to the soaring delinquency rates in office CMBS. As more companies adopt flexible and remote work arrangements, the demand for traditional office space has notably dwindled. This shift is reflected in the delinquency rates, which have surged to 10.4% in November 2024, just below the peak of 10.7% seen during the 2008 financial crisis.
The persistent trend of remote work has led to higher vacancy rates and lower rents in the office sector. Over the past two years, office CMBS delinquency rates have increased by 8.8 percentage points, outpacing the 6.3-point rise during the financial crisis. This rapid increase is largely driven by the oversupply of office spaces and the reduced need for physical offices as employee productivity remains high in remote settings.
According to Moody's, office loans account for approximately $831.1 million of the newly delinquent loans, contributing to nearly 70% of the total new delinquencies in the CMBS market. The data underscores the urgent need for market adjustments, such as repurposing or demolishing underutilized office spaces, to mitigate the financial strains on investors and the commercial mortgage market. Policies to encourage the conversion of office buildings into residential or mixed-use properties could offer some relief, but without substantial changes, these high delinquency rates are likely to persist.
Vacancy rates in the office sector have skyrocketed, exacerbating the financial woes of commercial mortgage-backed securities (CMBS). As of the second quarter of 2024, the office sector's vacancy rate hit an all-time high of 20.1%, surpassing the pre-pandemic record of 19.3% seen during the savings and loan crisis in 1986 and 1991.
This unprecedented rise in vacancy trends is largely attributed to the shift towards remote and hybrid work arrangements, which has greatly reduced the demand for traditional office space. The national vacancy rate continued to climb, reaching 19.4% by the end of October 2024, an increase of 160 basis points year-over-year.
Concomitantly, rental pricing has been impacted, although not uniformly across all markets. While the average U.S. office listing rate stood at $32.79 per square foot, up 3.3% year-over-year, certain markets like San Francisco, Austin, and the Bay Area recorded vacancy rates as high as 27.7%, 27.7%, and 26.4%, respectively.
These high vacancy rates and the resultant financial strain are reflected in CMBS delinquency rates, which soared to 8.4% in September 2024, a level not seen since the Great Recession in 2010. This surge underscores the urgent need for adaptive strategies, such as repurposing underutilized office spaces, to mitigate the ongoing distress in the office sector.
As office vacancy rates soar, property values have plummeted dramatically. According to Moody's Analytics, the value of office commercial real estate is likely to plunge 26% by the end of 2025, driven by companies adjusting to the work-from-home trend by shrinking workspace or moving to cheaper properties.
This property devaluation is exacerbated by a construction oversupply. Despite the declining demand, newly completed properties continue to enter the market. For instance, the completion of new constructions across the office, retail, and industrial sectors is projected to reach 136.3 million square feet in the second quarter of 2024. This influx of new space, coupled with tenants leasing less space than they are vacating, results in a significant net absorption deficit, totaling 19.2 million square feet in the second quarter of 2024.
Moody's notes that valuations across all commercial real estate types will probably slump 10% peak-to-trough during the next 18 months, with the office subsector being hit the hardest. The increase in vacancy rates and the completion of new projects further complicate the market, making it challenging for asset managers and developers to retain tenants and manage costs.
Facing the stark reality of plummeting property values and soaring vacancy rates, the office sector of commercial real estate is forcing landlords and developers to contemplate drastic measures. One viable strategy to mitigate these challenges is through adaptive reuse, a process that involves repurposing existing structures for new uses. This approach not only preserves the architectural heritage of the building but also aligns with the growing demand for sustainable practices in the real estate sector.
For instance, converting underutilized office spaces into mixed-use projects, such as residential units, co-working hubs, or retail spaces, can be a lucrative market adjustment. According to industry insights, great locations, particularly those at prime "main and main" spots, are intrinsically attractive for such transformations.
Working with local, experienced partners is essential for maneuvering the complexities of adaptive reuse, including unexpected renovations and local approvals processes. Additionally, securing tax credits, such as historic tax credits or state-sponsored programs, can greatly aid in financing these projects, although these processes can be arduous and take years to gain approvals.
As commercial mortgage-backed securities (CMBS) delinquency rates soar, the office sector is facing unprecedented distress. Office CMBS delinquencies have surged to 8.4%, a level not seen since 2010, driven by the pervasive shift to remote work and overbuilding.
With a staggering 20.1% office vacancy rate, a 30-year high, over 900 million square feet of office space remain empty. This vacancy crisis is threatening property values and tax revenues, pushing cities toward an economic doom loop.
Experts warn that unless significant market adjustments, such as repurposing vacant properties, are made, delinquency rates will continue to escalate, further straining the commercial mortgage market.
