"Credit Shock" In Commercial Real Estate | John Toohig, Victor Calanog, and Thomas LaSalvia

Episode Summary

Executive Summary: The panel argued that commercial real estate is in an “extend and pretend” phase: property values are down, especially office, but cash flows remain resilient because the economy and tenants have held up better than expected. The biggest near-term risk is the maturity wall and higher-for-longer rates, which are pressuring refinancing, widening bid-ask spreads, and slowing transactions.

Main Topics: Commercial real estate is in an extended stress phase, not a crash (Priority: 5/5): John said the market is seeing signs of trouble, but not a full financial crisis yet. The panel framed the current environment as maturity defaults, refinance strain, and delayed price discovery rather than immediate forced liquidation. Property values have declined, but appraisals and transaction data lag (Priority: 5/5): Victor explained that institutional CRE values have fallen since mid-2022, led by office, but valuations rely heavily on appraisals and sparse trades, making the true decline hard to pin down and causing public/private valuation gaps. Cash flows remain relatively strong across many sectors (Priority: 5/5): Thomas emphasized that rent and occupancy trends have held up better than feared in multifamily, industrial, and even much of office, because corporate and consumer fundamentals have remained resilient. The debt maturity wall and higher rates are driving refinancing stress (Priority: 5/5): John detailed how many CRE loans are 5-year structures that now face resets or balloon payments. If borrowers cannot refinance at much higher rates, lenders are forced into extensions, modifications, or defaults. Office is the clearest distress case; multifamily and industrial are stronger (Priority: 4/5): The panel repeatedly identified office as the poster child for distress due to remote-work uncertainty and structural demand risk, while noting multifamily and industrial still benefit from housing shortages, e-commerce, and stable demand. Capital is retreating from traditional lenders, creating opportunity for private credit and selective buyers (Priority: 4/5): Banks and life insurers are pulling back because of funding costs and reserves, opening space for private credit, opportunistic lenders, and buyers with dry powder to capture higher returns on distressed or mispriced assets. Regional and global differences matter a lot (Priority: 3/5): Victor contrasted the U.S. with Canada and Asia, arguing that slower markdowns, more amortizing debt, and higher office occupancy abroad make the crisis far less severe outside the U.S., while China’s real estate issues are more idiosyncratic than systemic.

Key Arguments: CRE is not yet in a full-blown crisis; it is still in an extend-and-pretend / slow adjustment phase. Higher interest rates are compressing lender margins and making refinancing harder, especially for maturities in the next 12-18 months. Office is the main problem sector because its future space demand is structurally uncertain. Cash flows for multifamily, industrial, and much of retail remain strong enough to delay widespread forced sales. Transaction volumes are low because sellers and buyers are far apart on price; this makes valuation transparency poor. Public REIT prices tend to lead private market valuations by roughly two to three quarters. Traditional lenders are pulling back, but this is creating lending and acquisition opportunities for private credit and selective buyers. Insurance costs and climate risk are increasingly part of CRE cash-flow stress, especially in certain geographies. A broad economic recession would likely trigger more serious CRE distress, but the panel does not see one as imminent. Canada, Asia, and some non-office sectors show materially less stress than U.S. office, largely due to slower rate hikes, amortizing loans, and stronger occupancy.

Data Points: Aggregate CRE price decline (Wall Street Journal citation): 16% since March 2022 - Jack cited this figure for the broader U.S. commercial real estate market. Office price decline (Wall Street Journal citation): 31% - Jack cited office as the weakest major CRE sector. Industrial/warehouse price decline (Wall Street Journal citation): 8% - Jack cited industrial as comparatively resilient. Multifamily price decline (Wall Street Journal citation): 20% - Jack cited apartment buildings as down meaningfully. Institutional-grade CRE price decline (NACREIF-like benchmark): 10.23% - Victor said institutional-grade properties fell about this much from mid-2022 to mid-2023. Institutional office decline: 18.4% - Victor said office led declines in institutional-grade CRE. Retail decline: 5.72% - Victor said retail had the least decline in his benchmark because it had less run-up and has been under pressure for years. Multifamily decline: 8.8% - Victor’s benchmark figure for multifamily since mid-2022. Industrial and hotel decline: About 7.3% to 7.4% - Victor’s benchmark figures for these sectors. Institutional properties tracked: 10,893 properties - Victor said the valuation index was based on around 10,893 institutional-grade properties. Office CMBS maturity defaults this year: 36% - Thomas said 36% of office CMBS loans that matured this year entered maturity default. Office CMBS maturity defaults in June: 69% - Thomas cited an especially high maturity-default rate for June maturities. August CMBS payoff rate: 16% - Thomas said only about 16% of August maturities paid off/refinanced. August CMBS unpaid amount: $509.5 million - Thomas said this amount did not pay off in August maturities. Fed rate hikes: 525 bps in over a year - Jack cited the rapid rise in rates as a core driver of stress. U.S. 10-year Treasury: Above 4% - Jack framed current borrowing conditions relative to higher yields. Loan structure frequency: “5-5” loans common - John explained many CRE loans are fixed for five years and then adjust, often with balloon risk later. Public/private valuation lag: 2 to 3 quarters - Victor said public REIT valuations typically lead private valuations by this amount. Canada office markdown: About 5% - Victor said Canadian office markdowns are far smaller than U.S. office markdowns. U.S. vs. Canada rate hike delta: 75 bps difference - Victor contrasted the speed and magnitude of rate hikes in the U.S. vs. Canada. U.S. property price run-up from 2020 to mid-2022: Over 20% - Victor used this to explain why U.S. prices have more room to fall than Canadian prices. Canada property price run-up from 2020 to mid-2022: About 10.2% - Victor contrasted Canada’s smaller boom with the U.S. IO loan prevalence in U.S. CMBS: 51% to 88% - Victor said interest-only loans became much more prevalent from 2013 to 2021. 2013 bank/life company CRE lending share: 38% amortizing mix mentioned - Victor said banks and life companies have more amortizing loans than CMBS. 2023 CRE originations forecast decline: About 38% - Victor cited MBA forecast for total CRE lending volume decline. Funding costs: CDs at 5%, FHLB at 5% - John said higher deposit and wholesale funding costs are squeezing lenders. Multifamily occupancy: About 95% - Thomas said occupancy remains very high despite new supply. Class BC multifamily occupancy: 97% - Thomas said lower-tier multifamily is effectively full. Affordable housing / LIHTC occupancy: 98% to 99.5% - Thomas cited extremely tight occupancy and waiting lists. Rent burden threshold: 30% of household income - Thomas said national rents recently crossed HUD’s rent-burden definition. Housing shortage: 2 to 5 million units - Thomas cited various estimates of the U.S. housing supply gap. Real estate allocation in institutional portfolios: 10.8% in 2022; 11.1% expected in 2023 - Victor described institutional capital allocation trends toward real estate. Office physical occupancy (Cushman/analytics-style measure): Under 50% in the U.S. - Victor said U.S. office occupancy remains below half of pre-pandemic levels. Office physical occupancy in Canada: 52% to 53% - Victor said Canada is slightly better than the U.S. Office physical occupancy in Asia: 80% to 110% of 2019 levels - Victor said some Asian markets have recovered strongly.

Pivotal Quotes: "I think it's extend and pretend at the moment." — John Tuhigg: His opening characterization of the CRE market’s current phase. "The poster child, unfortunately, is the office sector." — Victor Kalanog: Victor identifying the clearest area of distress and structural uncertainty. "No forced sellers presently. There's some opportunistic sellers." — John Tuhigg: He described how owners are responding to higher rates and margin compression.

Implications: Expect continued valuation pressure, especially in office, with more refinancing stress as maturities roll forward. But strong cash flows and selective asset quality mean opportunities are likely for patient buyers, private credit, and lenders able to price risk correctly.