Commercial real estate has undergone major stresses and changes through and after the pandemic. That’s translated to pressures and challenges ahead for lenders, says S&P Global Market Intelligence in a report about trends and opportunities shaping up for 2025.
One factor is interest rates. The Federal Reserve has cut 75 basis points from the federal funds rate between the September and November FOMC meetings. That is progress for shorter-term rates. If longer-term rates also started to fall, it could mean good news for CRE borrowers, but yields seem to be holding above the 4.3% to 4.4% range. For many properties, particularly in the “embattled” types, that may not prove enough of a reduction.
As S&P Global put it, bankers will “feel some pain in the CRE books,” especially as borrowers look to refinance and find that task increasingly harder. That seems like a safe bet, given what has been happening in the markets of late.
The firm’s analysis of national property records found that the average interest rate on loans made in 2024 through August was 6.2%. Maturing loans, however, were an average 4.3%. Refinancing means a nearly 200-basis-point increase. About $950 billion in CRE mortgages were expected to mature in 2024. The number will hit a zenith in 2027 at $1.26 trillion, based on data from CoreLogic, as GlobeSt.com previously reported.
This is where things get more complicated. S&P Global projects that continued Fed interest rate cuts should lower the impact of higher debt service on refinancing. However, the prospect of more reductions is far less certain than many thought. Fed Chair Jerome Powell effectively pulled the punchbowl away from markets by saying in a speech at the Federal Reserve Bank of Dallas, “The economy is not sending any signals that we need to be in a hurry to lower rates. The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully.” In other words, don’t count on the pace, number, or size of future cuts.
Some property types have seen lower cash flows. Additionally, higher taxes, utilities, and insurance costs combined with higher interest rates on refinancing put additional strains on net operating income and debt service coverage ratio.
Office has been the biggest concern due to hybrid work reducing cash flows, increased expenses, and the difficulty in refinancing many properties. About 10% of the $950 billion in CRE loans maturing in 2024 are office buildings. Some will likely default and force workouts and sales. Owners of older properties may experience difficulty finding new tenants and could have to put significant capital into remodeling and upgrades, adding to fiscal strain.
But S&P Global noted that banks have been increasing reserves against risk. Wells Fargo & Co., PNC Financial Services Group Inc., Truist Financial Corp., and Citizens Financial Group, Inc. have increased reserves to 8% or more of their office portfolios.