Foreclosure rates on commercial properties recently reached their highest rate in nearly a decade. This could be a sign that the sector’s downturn is approaching a market bottom.
In the second quarter of 2024, portfolios of foreclosed and seized office buildings, apartments, and other commercial properties reached $20.5 billion, according to data provider MSCI. This marks the highest quarterly figure since 2015 and is a 13% increase over the first quarter. High interest rates and the slow return of workers to office buildings are to blame. Defaults and other types of distress have steadily been building up to near-historic levels since the pandemic. Many lenders have been reluctant to take over properties in hopes of a recovery and avoiding the expense of foreclosure actions, but recovery has become less and less likely.
Jade Rahmani, an analyst at Keefe, Bruyette & Woods, told Peter Grant of The Wall Street Journal, “Lenders will do everything in their power to avoid that.” Unfortunately, it is starting to look like it may no longer be an option. Distress is working its way through the financial system, with lenders concluding that obsolete office buildings will not recover their former values, even if interest rates did decline. This is resulting in more sales of foreclosed properties and distressed mortgages, and an increase in short sales, where lenders and borrowers work together to unload properties for whatever price they can get.
Federal Reserve Chairman Jerome Powell remarked that risk in commercial property, “will be with us for some time, probably for years,” in a Senate testament earlier this month.
If the U.S. economy slides into recession, it is possible that commercial property values could decline even further. During a recession, companies would start laying off workers and unloading their offices. However, in previous downturns, comparable surges in foreclosure activity have indicated the approach of a market bottom. Once lenders seize a property, they are typically quick to sell it. This process helps determine property values after long periods of sluggishness in the sales market.
While office buildings are the most troubled property class, apartment buildings have been hit hard as well. In the second quarter, office property seized in foreclosures was up about $5 billion from the second quarter of 2023, according to MSCI. Apartment buildings had an increase of $975 million during the same period. Major real estate companies like KKR Real Estate Finance Trust and State Farm Life Insurance have conducted foreclosures on office complexes in recent months.
“Lenders are more dispassionate about values and that’s a sign of a cycle moving toward a bottom”, said Matt Pestronk, a developer who has purchased two discounted office buildings in the district for conversion to residential. Nicholas Seidenberg, managing director at the real-estate investment banking firm Eastdil Secured, also mentioned values when speaking to The Wall Street Journal. “This cycle, a lot of investors believe office values are challenged,” he said “They’re saying: ‘Hey, I’m going to just walk away and not fight.’” This grim attitude toward commercial property value certainly reflects the mood of the market.
