Commercial Mortgage-Backed Securities Distress Is Peaking — Again

Discussions around distress that have dominated the commercial mortgage-backed securities (CMBS) market have taken a turn for the worse, with data points shifting in the same unfavorable direction for months. 

The distress rate has steadily trickled up, approaching a peak, with office distress hitting an all-time high of 8.89 percent in July with another maturity wall nearing. Analytics firm Trepp found that, of the $65 billion in CMBS loans set to mature by the end of 2026, $37 billion are hard maturities with no extension options. An analysis from records cruncher PropertyChecker found hard maturities will hit especially aggressively in the latter half of the year. Some 39 percent of the year’s hard maturities fall in the fourth quarter. 

Still, while the facts seem clear, there isn’t exactly agreement on the significance. Some in commercial real estate find solace in more aggressive actions to resolve loans, and remain optimistic that everything will work out, aside from a handful of troubled loans. Trepp even said  in a recent report that the maturity wall is really more akin to “specific pockets of refinance pressure.”

Others see ominous storm clouds on the horizon, ones growing more dangerous due to larger economic distress. 

There’s “nothing systemic to worry about,” said Mike Haas, founder and CEO of CMBS tracker CRED iQ, who argues the market is both healthy and supportive of new deal activity. 

Mark Silverman, partner and CMBS special servicer team leader at law firm Troutman Pepper Locke, doesn’t think the sky is falling, but it’s “adjacent to Chicken Little” because the volume of maturities is too significant to ignore. While he doesn’t expect a “terrible tsunami” of issues, he can’t see how the market collectively sidesteps this particular 2026 maturity wall. 

“You have bad underwriting at origination deals, and then you have market-driven problems,” said Silverman. “Those are just naturally going to coincide and hit at the same time.”

The diversity of opinions on the overall health of CMBS stems in part from the market’s own diversity, what many have described as a bifurcation. Analysts and experts, such as Liza Crawford, co-head of global securitized at asset manager TCW Group, have long spoken of that bifurcation in the market, both in terms of existing loans and originations.  

Many optimists point to the fact that new loan activity is through the roof. Trepp has tracked $76.2 billion of CMBS origination from the start of the year through the end of July, $58 billion of which is related to single-asset, single-borrower (SASB) loans. Originations, said Crawford, have trended away from conduit loans to mostly SASB, a shift she attributes to an attempt to have more certainty and control over risk, as well as a need to be nimble to capture what many investors see as growing opportunities. 

Even some of the floating-rate loans coming to final maturity, which can be challenging to untangle due to interest rate shifts, can reach a negotiated extension, said Crawford. “There are still extension stories in the market,” she said. 

“There’s a better understanding that lower rates are not going to bail out loans that don’t make sense,” Crawford added. 

However, a significant number of loans are coming due later this year at a time when interest rates remain elevated and cash to refinance remains in shorter supply. Pessimists highlight a troubling overlap of problematic loans and continually poor property performance. Loss severities — the percentage of the principal balance lost via liquidation by a special servicer — continue to increase, which means more deals getting resolved for lower returns. A number of mall loans created and modified during COVID-19 are also coming due, said David Putro, ratings agency Morningstar’s head of commercial real estate analytics. That can worsen overall distress. 

Following the slow, steady rise of real estate-owned properties, the number of bank modifications on these loans will dry up and stop happening, said Haas.

Another bifurcation is between office and multifamily assets in particular. Return-to-office policies and increased demand for Class B office help office-anchored CMBS assets on the bubble. At the same time, though, multifamily has struggled with stagnant operating incomes and a cacophony of rising costs. Loans originated between 2021 and 2023, based on rosy rental growth and operating cost projections, have been clobbered by a shift in multifamily fundamentals and now find themselves on the chopping block. 

“There’s not going to be a sufficient number of lenders that are comfortable underwriting refis that make sense on a lot of these deals,” Silverman said. “That’s a cagey way of saying
multifamily isn’t necessarily going to be underwritable on its face if the property fundamentals aren’t there.” 

Underwritten with healthier rent growth, such as a 3 percent annual increase, these assets have endured years of flat rents, while costs like insurance skyrocket. Crawford said that of the 2023 vintage of multifamily CMBS, 24 percent are delinquent and about 27 percent find themselves in special servicing.

“In general, inflation has really crushed these multifamily assets,” said Haas. “Those with floating-rate loans taken out during record-low interest rates are feeling the pain the most.”

Office hasn’t escaped its own challenges, but the sector is showing much more health overall than one might have predicted a few years back, when remote work was regnant and vacancies stubbornly high. Leasing momentum, especially in AI-happy San Francisco and a resurgent Manhattan, has pushed demand into Class B properties and eased a potential CMBS distress situation, said Putro. There’s a cash flow story that appeals to lenders, even if realistically it depends on spending to renovate Class B space. 

And, overall, Troutman Pepper’s Silverman observed, the market has found ways to repurpose, reposition, sell and transact office assets despite the distress. Nobody is getting unbelievable, bottom-of-the-barrel pricing on these assets, Silverman said. Instead, they’re getting average deals, and servicers aren’t getting crushed.

“The ecosystem is self-sustaining,” he said. “I think that’s what’s giving folks optimism.”

There’s still trouble, though. Haas predicts a number of monster losses on antiquated office space. Bond investors might even take a loss in some situations, and “that never happens.” 

Also, the concentration of risk in second-tier and tertiary markets remains a heavy weight that can’t be undone easily. There’s simply too much square footage and concentrated loan distress. These are markets with less volume, less experience with servicers, and less speed to develop, prolonging recovery and redevelopment, Silverman said.

An analysis from analytics firm Atrium found certain metros with significant struggles in terms of CMBS distress: Minneapolis (70.6 percent) and Denver (66.6 percent) lead the country, and most of Minneapolis’ distressed office CMBS loans are already real estate-owned (in other words, owned by the lender).

It isn’t news that the CMBS market is filled with uncertainty, and a lot of creative financing and deal-making will be needed to unwind these distressed assets. The positive case for CRE sees the slow, steady nature of extensions and modifications continuing to spread out the pain. CRED iQ’s Haas also points to the conventional banking sector, which has seen record profits and capital sitting on the sidelines, ready to do deals.

“Banks are pretty strong, and I don’t think they’re all going to blink at once,” he said. 

But there’s always more trouble over the horizon. Atrium found $34.5 billion in office CMBS maturities hitting next year, including in New York ($8 billion), Boston ($3.7 billion) and San Francisco ($3.3 billion). Crawford believes that there isn’t massive, systemic risk, but she said there could be acute pain in some portfolios where investors and analysts aren’t paying attention to multifamily metrics in particular. Instead of looking under the hood closely, they may miss just how disjointed revenues and costs have become for certain challenged properties. 

And then there’s the bigger worry of the overall economy, where consumer sentiment and spending continue heading in the wrong direction. Silverman said that if consumers continue to feel completely overwhelmed by inflation and stagnant incomes, that will reduce spending, slowly amping up pressure on properties that will eventually show signs of distress. 

“If you can’t beat back inflation and you can’t otherwise solve some of these other macro problems,” he said, “how do you solve the micro problem of your loan maturing?”