Commercial mortgage-backed securities (CMBS) market volume exploded last year, as issuance reached $108.2 billion in 2024, up from $40.6 billion in 2023, according to Trepp, which specializes in CMBS and commercial real estate (CRE) data and analytics.
Nevertheless, there are signs of trouble as delinquency rates across most sectors, and especially office, begin to climb. Office-sector transactions are likely to see a reckoning in 2025 that could be exacerbated by President Trump's Department of Government Efficiency (DOGE).
Overall CMBS delinquency rates peaked at 10.34% in July 2012, in the wake of the financial crisis, Lonnie Hendry, chief product officer at Trepp, said in a recent webinar. As the pandemic unfolded in 2020, overall delinquencies skyrocketed again, to 10.30%, driven by the lodging and retail properties while office CMBS delinquencies remained stable, at around 3%.
The overall CMBS delinquency rate proceeded to fall by more than half by late 2022 before picking up again in early 2023, although this time fueled by office properties.
"The highlight is that the office sector has jumped off the page," increasing to just over 11%, Hendry said, adding that the office sector's previous delinquency highwater mark was back in 2012, in the wake of the financial crisis, when it peaked at 10.7%.
Upwards of $36 billion in office loans, most originated when mortgage rates were significantly lower, are slated to come due in 2025, weighted toward the first half of the year, according to Trepp.
"If you look at what has gone delinquent at maturity, we could easily see office delinquencies hitting 12% to 14% over the next couple of quarters," Hendry said, noting that Trepp views a loan as delinquent when the borrower misses two consecutive payments.
Maturity stress increases
Raising the stakes, the majority of delinquent loans as of December are unable to refinance the original balance with just six months remaining until maturity, according to Trepp. Higher interest rates and property-income deterioration are factors fueling that "maturity distress," and many CMBS loans pay interest-only through some or all of their terms, leaving the bulk of principal to be refinanced
In January 2022, about 40% of delinquencies were due to maturity distress, Trepp's data shows, and now it is 75%. Reporting refinancing challenges may in some cases be a strategy to extend the loan with an existing lender, to avoid refinancing at a much higher rate.
"But at some level it comes down to the math being the math," Hendry said. "A borrower that has not paid down any principal on an interest-only loan, [when] interest has effectively doubled and net operating income has not increased, is in a really tough spot."
"We think this is one of the defining stories of [today's] CRE," said Thomas Taylor, a senior manager of research at Trepp who also participated in the webinar. "It will present a lot of stress to the original borrowers but opportunity to new buyers trying to [invest in properties] at a lower basis."
Investors want SASB
The office loans facing the biggest challenges, unsurprisingly, tend to be for older buildings, especially Class B and Class C structures, but also many "commodity" Class A buildings without the amenities and top locations of Class A "trophy" properties. Single-asset, single borrower (SASB) CMBS typically securitize the trophy properties, and since rates began their rapid climb in 2023 they have found significant demand by investors compared to conduit CMBS, which pool numerous and typically diversified loans.
"People see SASB CMBS as easier to analyze," said Tracy Chen, portfolio manager at Brandywine Global. "When lots of loans are mixed up in a conduit, it's hard to know where the next crisis will happen, and usually the properties are of less quality."
SASB and conduit CMBS played tag team in terms of issuance volume in 2023, but by 2024, when it was clear that high interest rates would linger, SASB deals took off. In 2Q 2024, $20 billion in SASB were issued compared to just over $5 billion in conduit, according to Trepp. The fourth quarter's SASB volume of $21 billion was still significantly more than conduit's just-under $10 billion, but the gap had narrowed.
Returning investor interest in conduit CMBS deals likely stems in part from their stellar performance, with BBB tranches returning upwards of 20%, Chen said, adding that new deals tend to have shorter five-year maturities, compared to the traditional 10 years.
SASB CMBS are especially attractive to investors because the loans typically are for newer properties or iconic older buildings such as One Rockefeller Center, for which a $3.5 billion deal was inked last October, that have restaurants, gyms and other popular amenities and have maintained stable and high occupancy rates.
DOGE impact
Additional distress among older-property loans may come from the federal government's General Services Administration, the signatory on all federal leases. It currently leases 149 million square feet of office space nationwide, a majority of which is in Class B or C structures, for which it pays more than $5 billion in annual rent, according to Trepp. Half or more of many federal employees have worked remotely since the pandemic, and on inauguration day Trump signed an executive order requiring them to return to the office. The federal government has continued to pay full rent on properties it leases, of which 51 million square feet are in Washington, D.C., so those landlords won't benefit directly by the return-to-office. However, the move could prompt private companies to follow suit, a boon for surrounding non-office CRE.
Trepp found, however, that 2,500 GSA leases have the contractual termination rights over the next four years, low hanging fruit for the DOGE, especially should the Trump administration succeed in significantly reducing the size of the federal government. Terminating half of those leases, Trepp says, reduces landlord profits by $550 million and lowers values--using average earnings multiples—by more than $7 billion.
Many of these buildings, given their age, would likely otherwise be struggling to perform in the current market, so if the GSA backs out of the leases, it could further disrupt the already fragile office market.
"It's a topic that's not going to go away, especially if DOGE starts to get some momentum and actually starts to execute at some level," Hendry said. "The numbers are very large and the impact could be very significant."
