Why Recession Could Double the Rate of CMBS Loan Defaults

By the end of 2023, Fitch Ratings projects that the US CMBS loan default rate will have risen from its October 2022 level of 1.89% to between 4.0% and 4.5%. The firm cites increasing interest rates, ongoing inflation, and sluggish economic development as factors, with a minor recession beginning in the middle of next year.

According to the company, Fitch forecasts increased delinquency rates for all key property sectors next year. Multifamily, office, and industrial rates will surpass their previous peaks, according to the prediction. Retail and hotel prices, which are already the highest of all property kinds, will rise much further.

According to the estimate, many more new delinquencies, in particular maturity defaults, are expected. Due to the same variables that will increase defaults and distressed sales, as many in the CRE industry have been telling GlobeSt.com: greater refinancing costs, pressure on CRE fundamentals like rents, and rising cap rates, special servicing will still exist but at lower levels. The debt loads on a property undergoing a refinance will be larger, and there may be a requirement for less leverage, necessitating the need for extra funding from investors. However, rent growth has generally slowed down, and it typically fails to maintain prior net cash flows.

All major property categories will see an increase in delinquency rates. The highest-priced property types, retail, and hotels, will see further price growth, while multifamily, office, and industrial prices will rise above their previous peaks, according to a report by Fitch.

Retail, in particular, will be pressured by inflation and sluggish wage growth, which will impact consumer spending and the capacity to pay rent. In addition, Fitch predicts that numerous Class B and C mall loans that are coming due will default.

Hotel delinquency will rise, although Fitch doesn’t anticipate it to reach its 18.4% epidemic peak. For 2023, the agency stated that forward room bookings and pricing projections are high, supported by growing group room nights and healthy leisure demand. A recession will further postpone [the final recovery to pre-pandemic performance] even though 2023 is not likely to match the strong rebound of hotel performance measures in 2022.

With hybrid work arrangements, reduced demand for office space, rising expenses, and tenants moving to higher-quality workplaces, older and lower-quality B and C properties in the office sector are at the highest risk of default.

When compared to other types of housing, multifamily is in comparatively excellent shape since property prices and consumer mortgage rates prevent many people who otherwise would have bought a home from doing so. But as costs increase and rents remain stable or even decline over time, cash flow will deteriorate.

While still in demand, industrial tenants will notice a slowdown in rent increases as a result of the recession’s impact on business as a whole.