CRE Tenants Have Missed Billions in Payments. Which Sectors Are the Most at Risk?

By Hugo Dante

The first two quarters of 2020 were marked by punishing economic data. The COVID-19 pandemic brought a decade-long expansion to a halt and sent the world into global recession. Few sectors of the economy have been spared from the effects of the virus; commercial real estate is no exception.

CRE lending, nearly $4 trillion in size, makes up a significant portion of the portfolios of banks, insurance companies and investors. The commercial mortgage backed securities segment offers a window into CRE trends. CMBS accounts for approximately $1.4 trillion of outstanding CRE loans. More than half of CMBS collateral, $800 billion, is multifamily loans. Other large segments include office space, retail and hospitality.

Hospitality and retail businesses were significantly impacted at the beginning of the crisis. As shutdowns peaked in April, these sectors shed millions of jobs, experienced debt downgrades and countless businesses struggled to stay afloat. Rent collections plummeted as a result; CBRE Group estimated April retail rent collection rates of 20 to 40 percent. While economic data for June shows some positive signs—with re-openings across the country spurring significant job recoveries in the service sector—delinquency rates in retail and hospitality remain elevated. Additionally, CRE balances added to watch lists for special servicing continue to rise, indicating further trouble ahead for retail and hospitality.

Beyond retail and hospitality, warning signs are starting to appear in other market segments as well–most notably, a sharp rise in June delinquencies for healthcare (facing COVID-related capacity and resource strain and a halt on elective procedures) and multifamily. Thus far, multifamily properties have benefited from legislative and policy support though the CARES Act, forbearance by the GSEs, the SBA’s Paycheck Protection Program, expanded unemployment benefit and stimulus checks provided to rent-paying tenants. Multifamily landlords are likely to see more strains going forward as governmental payments start to dwindle, legislative relief ends and the extra liquidity flushing through the economy no longer keeps struggling businesses (and their employees) afloat.

There are various risk areas to CRE going forward. First and foremost is the possibility that a significant rise in pandemic cases could force re-implementation of lockdowns. Note that cases began to surge again in July. If lockdown measures are re-implemented, a significant portion of CRE could end up underwater.

Second, lingering high unemployment and resultant weak wages will strain multifamily rent collections and business bankruptcies could do the same for other CRE loans. According to the U.S. Bureaus of Economic Analysis and Labor Statistics, national consumer income was down 4.2 percent in May and the unemployment rate was 11.1 percent .

Third, CRE prices dropped 11 percent over the past three months, according to Green Street Advisors. During the Great Recession, property values fell 37 percent. If the CRE market follows a similar path, prices will decline further. Dropping prices would put pressure on LTV ratios, debasing the collateral for loans.

Finally, the rapid adoption of working remotely is reshaping how employers approach office space and remake migration patterns, altering demand for commercial properties.

The commercial real estate market is deeply connected to the pulse of economic activity. While it is too early to assess the full impact, COVID-19 will permanently reshape commercial real estate in the U.S.

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About Author

Hugo Dante

Hugo Dante is a research associate in the Economic Policy and Research group at the ABA.