Report: Nearly One-Third of National Office CMBS Is Distressed

The volume of CMBS office loans either in special servicing or at risk of default has jumped from $26.6 billion in March 2023 to $52.2 billion in March 2024, according to KBRA. Out of a $168.4 billion national office CMBS securitization market, approximately 31 percent of all non-defeased CMBS loans that still have office as collateral are now distressed. 

“I think it’s a pretty tangible concern,” said Mike Brotschol, managing director at KCP and co-author of the report. “It’s probably the property type we’re thinking is most at risk and is positioned for outsized losses relative to other property types and asset classes.” 

Brotschol noted that dozens of headwinds are impacting the office sector following the shift in usage and rise of hybrid work since the COVID-19 pandemic struck four years ago. Cash-flow concerns stemming from record vacancies are making it harder to grow revenue, while higher concessions to attract tenants are impacting net operating income just as operating expenses are rising during a time of high inflation. 

To make matters worse for office CMBS, almost all of those loans are nonrecourse, meaning the lender can only take back the property, and not pursue other borrower assets. 

“Office as a property can be pretty capital intensive,” said Brotschol. “These are nonrecourse loans, so if borrowers no longer see upside, they won’t continue to commit capital when properties are operating in the red. And there’s capital hurdles to improve and maintain the quality of the assets.”  

Moreover, not all cities are created equal when it comes to CMBS distress. 

Of cities carrying more than $5 billion of outstanding CMBS office debt, Chicago took the cake with a distress rate of 75 percent — meaning 75 percent of the city’s CMBS balance collateralized by office debt is distressed. 

“It’s a really high number. It’s eye-popping for sure,” said Patrick Czupryna, managing director at KCP and co-author of the report. 

KCP’s next most distressed cities for office CMBS were Denver (65 percent), Houston (57 percent), Philadelphia (52 percent) and Atlanta (49 percent). New York and Los Angeles’ office CMBS distress rates were 25 percent and 30 percent, respectively. 

Both Brotschol and Czupryna emphasized that for many of these cities, particularly Chicago, the ratio of distressed CMBS office debt is augmented by the size of loans on specific office properties, notably large SASB loans. For instance, Willis Tower in Chicago carries a $1.3 billion SASB securitization originated in 2018; today the building’s cash flow reached $111 million compared to cash flows underwritten at $135 million annually.  

But some buildings are truly troubled. 333 South Wabash in Chicago carries a $240 million pari-passu loan across multiple CMBS conduits, but has been beset by declining cash flow and rising expenses recently, according to KBRA. The building’s real estate taxes jumped from $7 million to $11 million last year, and its largest tenant, Northern Trust, lessor of 45 percent of the property, plans to lay off 900 workers. To make matters worse, the building had a pricey $167.5 million renovation in 2019. 

“You have a problem on the absorption, revenue side plus rising operating costs are really putting a squeeze on cash flow,” said Czupryna. “When you have your basis increase, that really puts stress on debt service and debt service coverage … so we’re seeing that happen with a lot of floating-rate deals given the rise of rates.”

Brian Pascus can be reached at bpascus@commercialobserver.com