Lenders, Especially Banks, Are Starting to Sell a Lot More Loans on Office Buildings

And, speaking of Blackstone, an affiliate of the asset management giant last week announced it had bought a $1 billion performing senior mortgage loan portfolio from German lender Deutsche Pfandbriefbank. Office buildings in Washington, D.C., and Cambridge, Mass., secure the portfolio’s largest loans.

“There are literally multiples of [loan acquisition] opportunities compared to what we saw last year,” said Michael Gontar, CEO of InterVest Capital Partners, a diversified company that buys commercial real estate loans secured by offices and other assets. “Things are definitely trading. It’s a much more active market.”

Deal-breaking disagreements between lenders and potential buyers over the value of such loans have become less prevalent, Gontar said. “Last year, there was more of a disconnect on value,” he said. “In the last six months, we’ve seen that thaw quite a bit. Sellers are taking losses where they need to, which is basically everywhere.”

But losses on CRE loan sales — which are expected to easily run into the tens of billions — don’t pose the kind of systemic risk to the U.S. financial superstructure as the wobbly housing market did 15 years ago. Things are different now. 

The COVID-19 pandemic propelled the rise of a remote labor force that vacated office buildings. The office vacancy rate nationwide was 19.7 percent at the end of 2023, an all-time high, according to a research report from brokerage Cushman & Wakefield (CWK).

“Banks reported tighter standards and weaker demand for all commercial real estate loan categories,” according to an April survey of senior loan officers by the Federal Reserve. Office debt risk in particular has escalated in certain geographic pockets along with vacancy rates. 

The debt service coverage ratio of an office building, or operating income divided by debt payments, should be at least 1.25 to satisfy most lenders, according to Yardi, a property management software developer. But the debt service coverage of office building owners has slid in recent years amid higher interest rates and even higher vacancy rates. Yardi reported that March estimates of the debt service coverage ratio for office buildings averaged below the 1.25 threshold in 13 of 91 U.S. markets, including Manhattan (1.05), Chicago (0.90) and Oklahoma City (0.89).

As owners of office buildings began to adjust to the pandemic shock that shook the world in March 2020, the Federal Reserve delivered a financial shock in March 2022 by announcing the first of multiple increases in interest rates to fight inflation.

Terms to maturity on commercial real estate loans typically range from five to 10 years, so many CRE loans originating prior to 2022 have interest rates substantially lower than what lenders charge now.

“Let’s say you were paying 4 percent back then. Now, if you’re lucky you’ll get a loan for 7.5 percent. That’s the problem. You can’t get a loan to replace it,” said George Klett, a banking veteran who formerly served as chairman of the real estate committee at Signature Bank, which collapsed last year after a sudden withdrawal of deposits.

“The commercial loans at Signature were not a problem — they were performing loans,” said Klett, who blames impatient bank regulators for CRE loan problems at other banks. 

“It seemed they had orders from Washington to get on banks and try to force them out of commercial real estate,” he said. “The government should come in and maybe provide some below-market interest rates temporarily, rather than the banks selling these loans off and losing money.”

U.S. banks nevertheless appeared by the fourth quarter of 2023 to be preparing for losses on sales of office loans and other assets. They increased their combined provision expenses for future losses to $24.7 billion, in part because of “greater risk in office properties,” Martin Gruenberg, chairman of the Federal Deposit Insurance Corporation, said in a March 7 speech reviewing the banking industry’s performance. “With the exception of two pandemic quarters in 2020, the provision expense of $24.7 billion was the highest since the fourth quarter of 2010.”

Today’s problems in commercial real estate draw worrisome comparisons to the financial crisis of 2008, which stemmed largely from a meltdown in residential
mortgage-backed securities after housing values crashed.

One reason to believe that financial history won’t repeat itself due to problems with commercial real estate loans is the amount of capital available to buy them. The market for such loans broadened this year, said Gary Phillips, managing director at Eastdil Secured. 

“In 2023, it was almost all family offices and high-net-worth [individuals] and private buyers, and some converters here and there,” Phillips said. “In ’24, those two groups are still there, but we have institutional bidders as well.”

Some commercial real estate loan portfolios for sale are marketed privately from bank to bank, too.

“You’re not seeing those bank portfolios being actively traded on the public market, because they’re being sold to other banks,” said David Perlman, managing director and head of the New York office at Thorofare Capital. “Banks are buying those portfolios and basically repackaging them and selling them to asset managers.”

Asset managers, in turn, pay fees to banks that resell CRE loan portfolios. “They sell it to an asset manager at basically the same price they bought it for. But they charge fees,” Perlman said. “They’re getting heavy fees. They’re getting like 2 to 3 points on that portfolio, so it’s a pretty attractive profit.”

He also said he expects debt funds with loans secured by office buildings to start offering more of them for sale. “You’re going to start seeing funds doing it. You haven’t seen funds as much because they don’t know how to mark them down as fast [as banks],” Perlman said. “Banks sometimes jump out to revalue their portfolios quicker than debt funds, because there is more regulation around it.”

Of course, an alternative to selling an office building loan at a loss is seizing and selling the building through foreclosure. But taking back property can be costly too.

“An office can be a very capital-intensive product type, because you need to invest money in tenant improvements and leasing commissions,” said Peter Mekras, president of Aztec Group, a Miami-based real estate investor and merchant bank.

Vulture-style investors who crave asset acquisitions at fire-sale prices may be disappointed by robust competition for promising commercial real estate loans.

“When opportunistic situations come about, they often get bid up to levels that people probably had hoped they would not, just because there’s a lot of capital,” Mekras said. “We have just come out of a massive capital-raising cycle where there’s a lot of opportunistic capital.”

The amount of private capital available to acquire commercial real estate loans may ensure that problems with such loans don’t lead to a financial crisis like the one that threatened the U.S. banking system in 2008.

“In 2008, there wasn’t a lot of capital to finance deals. Right now, you have a lot of capital to finance deals and refinance current deals,” Perlman said. “Private capital is a much bigger part of the market now than it was back then. Banks are less significant now than they were during the great financial crisis.”