- Fixed Income Credit Analyst
United States, Intermediary
Change
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
Tough times have gotten even tougher for the commercial real estate (CRE) sector over the past month or so, starting with the well-publicized failure of Silicon Valley Bank (SVB) on March 10, 2023 — but not all areas of CRE are equally vulnerable to today’s stresses, so finding potential investment opportunities is all about knowing where to look.
A challenging environment for CRE
As of this writing, we have become more negative on the broad outlook for commercial mortgage-backed securities (CMBS) based on tightening credit conditions at regional US banks. Going into March, CRE was already facing stiff headwinds from substantially increased borrowing costs, declining asset values, and a generally slowing economy. The recent turmoil in the banking sector has only exacerbated these challenges, especially for weaker commercial properties.
Regional banks have historically been among the largest providers of CRE financing, accounting for as much as 70% of such lending by all banks, which equates to nearly 30% of total CRE debt financing. Shrinking credit availability from these regional banks will of course further restrict borrowers’ access to needed capital, making it more difficult to refinance a CRE loan and likely adding to downward momentum in property prices.
At this juncture, we are most negative on office buildings and regional malls — two commercial property groups that were already under tremendous secular pressures and are among the main components of a diversified CMBS pool. We still expect the grim story in the office segment to play out over several years due to the many long-term leases that are currently in place, although we are closely monitoring lease rolls given that vacancy levels are now higher than they were during the global financial crisis (GFC), including for subleased office space.
Possible CRE scenarios going forward
Similar to previous downturns in the CRE sector (notably, during the GFC and amid COVID-19), we expect loan special servicers to grant loan modifications and extensions to troubled borrowers as long as the latter can demonstrate a willingness to work with the servicers. Still, deal sponsors will likely need to contribute their own capital to help support underperforming assets, which may cause many of them to walk away from the properties (as we have seen with a few high-profile office loan defaults recently).
The special servicer “playbook” was successful during the GFC and COVID-19 because the CRE sector downturns were temporary. The risk case this time around is that the slump could prove deeper and more lasting for the office segment (similar to what we saw in retail), leaving many borrowers reticent to pony up fresh capital. On the positive side, loan maturities have typically been a catalyst for an uptick in defaults, and there is fortunately not a large number of loans scheduled to mature this year.
We believe borrowers who locked in cheap fixed-rate financing at low interest rates will be incentivized to extend their loans in order to buy time for borrowing costs to come down and lending conditions to improve. Borrowers who took out floating-rate loans, however, are already grappling with “payment shock” from higher rates and may thus be hard-pressed to meet the performance hurdles required to extend their loans (e.g., debt-service coverage ratios). Additionally, these borrowers would have to purchase new interest-rate caps for an extended loan period, which have become quite expensive following the sharp rise in rates over the past year or so. These factors could explain why some floating-rate borrowers are opting to walk away from their properties.
CMBS performance likely to vary by segment
Overall, we expect CMBS performance to vary considerably by property type and submarket in the period ahead:
- Within office, we believe higher-quality, newly constructed or renovated office buildings look poised to outperform older, lower-quality ones, as many borrowers may seek to take advantage of the recent weakness in this property segment to upgrade their office space.
- On the other hand, we are more positive on the industrial and multifamily property segments at this time. Despite softening fundamentals and higher financing costs, both segments benefit from stable net operating income and are starting from a position of relative strength.
- Given the dispersion we are seeing across and even within CRE property types, we believe skilled security selection will be critical going forward, as the bifurcation in performance between the weakest properties and the strongest ones will likely become more pronounced.
- CMBS performance is also likely to vary quite a bit from a geographic standpoint, with some global regions and countries apt to perform well in the coming months, while others may be prone to struggle.
- We think most AAA rated bonds should be well insulated from today’s hostile environment, but that more subordinate CMBS (e.g., BBB rated bonds) now face much greater risk of credit rating downgrades and potential loss of investors’ principal.
- While credit spreads for AAA CMBS have generally tracked those of investment-grade corporate bonds, they have widened of late, which may present an opportunity given their top credit ratings and robust structures (Figure 1).
- By contrast, spreads for BBB CMBS, where credit risk has grown, have decoupled from high-yield corporates (Figure 1). We are closely watching this fluid situation to evaluate whether or not it reflects appropriate pricing of current risks.
Figure 1
ICE Data, its affiliates and their respective third-party suppliers disclaim any and all warranties and representations, express and/or implied, including any warranties of merchantability or fitness for a particular purpose or use, including the indices, index data and any data included in, related to, or derived therefrom. Neither ICE Data, its affiliates nor their respective third-party suppliers shall be subject to any damages or liability with respect to the adequacy, accuracy, timeliness or completeness of the indices or the index data or any component thereof, and the indices and index data and all components thereof are provided on an “as is” basis and your use is at your own risk. ICE Data, its affiliates and their respective third-party suppliers do not sponsor, endorse, or recommend Wellington Management Company LLP, or any of its products or services.
Expert
Related insights
Showing
of
Insights Posts
Securitized credit: Normalizing, decelerating, or falling off a cliff?
Continue reading
4
min
Article
2025-10-31
Rate relief: Fed cuts half point, but says “economy is strong”
Continue reading
3
min
Article
2025-09-30
URL References
Related Insights
Stay up to date with the latest market insights and our point of view.
Read next
Showing
of
Insights Posts
Time for bond investors to take the wheel?
Volatility makes bond investing less straightforward, but it can also create opportunities, provided investors are in a position to "take the wheel" in order to capitalise on them.
8
min
Article
2025-11-30
Are bond investors ready for a US industrial revolution?
Portfolio Manager Connor Fitzgerald discusses why bond investors should ready themselves for a potential US industrial revolution and shares his perspective on how to reposition portfolios for such a scenario.
6
min
Article
2025-11-30
Securitized credit: Normalizing, decelerating, or falling off a cliff?
Our experts offer their views on the current conditions and outlook for the securitized credit market.
4
min
Article
2025-10-31
Rate relief: Fed cuts half point, but says “economy is strong”
Our expert explains the Fed's bold rate cut and some key takeaways for investors.
3
min
Article
2025-09-30
CLO equity insights: Private credit
Explore how the convergence of public and private markets is impacting CLO equity, including the unexpected benefit it has driven in recent years.
5
min
Article
2025-08-31
Private placements: A primer for corporate DB plans preparing to derisk
With many corporate DB plans exploring derisking opportunities, Portfolio Manager Elisabeth Perenick and Multi-Asset Strategist Amy Trainor discuss the potential role that private investment-grade credit, or private placements, could play and consider common questions about liquidity and allocation sizing.
9
min
Article
2025-08-31
Insurance Quick Takes: US life insurers’ utilization of private placements
In our latest Insurance Quick Takes video, Tim Antonelli discusses research on US life insurers’ use of private placement investments, and shares observations for insurers globally.
3
min
Video
2025-08-08
Still waiting…Fed wants more data before cutting policy rates
Our expert dives into Fed policy following the July FMOC meeting.
3
min
Article
2024-10-31
Office to multifamily conversions: Implications for CMBS investors
Our experts explore the emerging trend in some US cities of converting office space into multi-family units and its implications for bond investors.
5
min
Article
2025-07-31
Chart in Focus: Four key areas of opportunities in bonds amid Fed uncertainty
We discuss four key areas of opportunities in fixed income amid Fed uncertainty in the second half of the year.
3
min
Article
2025-07-31
Are US election probabilities now a critical driver of bond yields?
Our expert argues that the US election remains a critical catalyst for the bond market given the contrast between both parties as it relates to supply side policies such as trade and immigration, and to policy differences around taxation and regulation.
3
min
Article
2024-11-30
URL References
Related Insights