The bifurcation we’re seeing in the office market between sought-after trophy properties and those with occupancy challenges extends to the realm of distressed real estate as well, said James Shevlin, president and COO of CWCapital. In the second part of a two-part Connect CRE Distressed Assets Update webinar, Shevlin noted that it’s not the Class A properties that have landed in special servicing.

“We’re seeing B and C assets that have heavy capex needs, lower rates in the market, lower occupancy in the market,” he said. “Can we stabilize that asset? We can stabilize the asset, but it’s probably going to be at a much lower valuation.”

To stabilize properties that have become functionally obsolete, “Somebody’s going to have to find a different way to reposition those assets,” said Jenna Unell, VP, senior managing director – special servicing at Greystone. “I don’t think we’ve seen the bottom of those yet. I think there’s more to come on that.”

Not all troubled office properties are lost causes, though. Unell cited the owner of an office property in the Houston suburbs who was determined to make a go of it. The asset “just couldn’t get refinanced, but the borrower wanted to stick with it,” she said. “The borrower paid down principal, put money in reserves to do the TI work, and we put him on a pretty short string and then gave him another option down the road.”

Juan Cueto, managing director, head of real estate (REO) asset management at Rialto Capital Advisors, agreed. “We don’t want to foreclose en masse and take title on everything,” he said. So if you have a committed borrower, that bodes well for the long-term viability of that loan and hopefully it gets back to performing and ultimately pays off.”

Moderated by Sreve Pumper, executive managing partner, asset services and capital markets at Transwestern, the conversation also delved into engineering loan workouts, the challenges of selling at current pricing and how to proceed in a capital markets environment that hasn’t improved as rapidly as people had hoped two years ago. On-demand replays of Parts One and Two of the webinar can be accessed here.

As New York City led in 2024 CMBS conduit issuance for multifamily properties, so it is also leading an increase in multifamily conduit delinquencies, Kroll Bond Rating Agency reported.

The overall KBRA distress rate for apartment-backed conduit loans, which includes loans that are delinquent or current and in special servicing, was at 8.5% as of year-end 2024. NYC multifamily currently represents 43% of the multifamily distressed balance, with a distress rate of 14.4% at year-end. That’s more than double the city’s year-end 2023 distress rate of 7%.

The city’s multifamily distress rate was distinctly bifurcated by property age, according to KBRA. Pre-1974 NYC properties, which have a much higher proportion of rent-stabilized buildings, had a 25.1% distress rate by balance, compared to post-2000 properties with a distress rate of 2.9%. Manhattan had the highest distress rate of the five boroughs at 29.8%, followed by Queens (7.5%) and Brooklyn (3.2%).

Two months after launching a $1B venture targeting office-to-residential conversions, TF Cornerstone and Dune Real Estate Partners have already identified three buildings to turn into apartments. 

The fund, Alta Residential, is pushing to foreclose on a historic property in Philadelphia after buying a piece of the building’s distressed debt. It is also getting started on converting an office TF Cornerstone owns in D.C.’s central business district and is in final negotiations to take over a New York City property, TF Cornerstone principal Jeremy Shell told Bisnow in an interview.

The Fairfax, TF Cornerstone’s residential conversion of the former FBI headquarters in NYC.

Many of Alta’s projects will arise from distress in the office market and taking over problem loans, Shell said.

“A lot of these office buildings that are good conversion candidates, the values have eroded to the point where really the controlling position is in the debt,” he said. “So we’re looking at a lot of debt positions.”

The first target is the 1.4M SF Wanamaker office building in Center City, Philadelphia, where TF Cornerstone purchased the majority of the property’s CMBS loan. The foreclosure isn’t finalized — the building’s owner, Rubenstein Partners, placed it in bankruptcy proceedings last year — but Shell is optimistic.

“When we’re ultimately successful with that, we’re planning a conversion and repositioning of that historic building, which is very exciting,” he said.

TF Cornerstone, founded by brothers Fred and Thomas Elghanayan, owns and operates almost 12,000 residential units in Manhattan, Brooklyn and Long Island City as well as more than 4M SF of commercial, office and retail space between NYC; Washington, D.C.; Virginia and Pennsylvania.

The Alta fund, a partnership with New York-based Dune, is aiming to take on between 20 and 25 projects in total, Shell said, putting around half the equity toward deals in NYC and deploying the rest in target markets, including Boston, Atlanta, Charlotte, Raleigh, Los Angeles and San Francisco. 

The venture’s next projects could come from purchases out of foreclosure, buying debt and pursuing joint ventures with “people or banks who are in a situation where they need to ultimately reposition the office building that they’re currently sitting on,” Shell said.

The Elghanayans are no stranger to conversions. In 1997, Thomas Elghanayan — then president at Rockrose Development, a firm run by his two other brothers — converted 45 Wall St. from office to luxury residential as part of the Lower Manhattan Revitalization Plan. 

“Conversions are where Tom and Fred originally cut their teeth and had a lot of success over the years,” said Shell, who is Tom Elghanayan’s son-in-law. “We’re really excited to be going back into that space, now that the opportunity has presented itself.”

Including 45 Wall St., TF Cornerstone has completed 15 office-to-resi conversions spanning almost 5M SF, according to a company spokesperson. It also pulled off residential conversions at 95 Horatio St., which was previously a refrigeration facility in Manhattan’s Meatpacking District, and the Upper East Side building that used to house the FBI’s NYC headquarters. 

In the five boroughs, Alta is looking specifically at properties in the Financial District, Midtown, and parts of Brooklyn. 

The joint venture has a long history. Elghanayan worked with Dune CEO Daniel Neidich when the latter was at Whitehall Real Estate Funds, a hedge fund and private equity firm. Shell worked with Neidich after business school, Commercial Observer reported. 

Policy measures passed last year, including the 467-m tax break at the state level and the City of Yes rezoning that opens up more property conversions, have made conversions an appetizing pursuit for the first time in more than a decade, Shell said.

“Values of office buildings have come down, the incentives from the state are there in terms of tax abatements, and we think there’s a lot of opportunity that we’re going to be able to take advantage of in that space in New York,” Shell said. “I’m really excited about that because we haven’t seen that over the last 15 years, as much.”

Converting office buildings into housing has been pitched as a potential solution to two problems that cities across the U.S. are facing — what to do with older, underutilized office properties and how to create much-needed housing amid shortages across the country.

But ultimately, while conversions present an opportunity to take a chunk out of the housing crisis, Shell believes more policy action is needed.

“Conversions are not going to be the panacea or cure-all for New York City’s housing supply issues. Far from it,” he said. “It’s one tool that’s needed, and will generate thousands of new apartments and thousands of affordable apartments, but we need a lot more than that in order to address the housing shortage.”

The CRED iQ CRE CLO distress rate added 60 basis points in December – reaching a new high of 13.8%.  Underpinning the distress rate, December’s delinquency rate for collateralized loan obligations came in largely flat at 11.8%; while the special servicing rate saw a 180-basis point increase, reaching 9%.  

CRED iQ’s analysis revealed that that 61.9% of CRE CLOs loans are operating below a 1.00 DSCR (NCF), up from 59.2% last month. Net Cash Flow (NCF) is a key variable in calculating a loan’s DSCR which determines the strength and creditworthiness of a given loan.

Among metro areas, Indianapolis-Carmel continues to lead the U.S. with a 70.6% distress rate. However, that figure trims 270 bps from the November print of CRE CLO loans in some form of distress.

The CRED iQ distress rate includes any loans reported 30 days delinquent or worse, past their maturity, specially serviced or a combination of these.

Notwithstanding some recent high-profile return-to-office edicts by major occupiers, the office sector continues to be the biggest contributor to monthly increases in distress metrics. And as the experts brought together for the “Distressed Property Outlook: The First Inning” panel made clear, the cycle is just getting started. 

“I don’t know that the flood’s hit yet,” said Curt Spaugh, director, special servicing in response to an audience question at the in-person Connect Distressed Investment & Finance event, held Oct. 22 at the Luxe Sunset Boulevard Hotel in Los Angeles. “I know that for us, we haven’t liquidated a lot of inventory yet.” However, he continued, citing SASB and conduit CMBS along with CBD office properties, “you’ll see more of that in ‘25 and ‘26.” 

However, the panelists made it clear that there’s enough distressed activity at present to identify trends. Looking at office properties in Greystone’s special servicing portfolio, “The recurring theme there is that these are defaulting primarily at maturity,” said Jenna Unell, VP/senior managing director—special servicing. “There is little liquidity for office right now. So finding refinancing opportunities or some other type of transaction to pay off a loan is typically where we are seeing the distress.” 

Mitchell Hunter, chief commercial officer with Trimont, described his company’s current workload. “We’ve probably got about 12 or 15 [properties] that are currently in the foreclosure process that we hope to have title to by the end of the year,” he said. “And that’s all office product.” 

That being the case, the discussion covered the spectrum of major property types. “When I’m giving these numbers, I want to give you the other side,” said moderator Steve Pumper, executive managing partner with Transwestern. “So if I’m telling you 12.58% is going into special servicing for office, that means that 87% isn’t.” Retail isn’t far behind in terms of special servicing percentage, and both lodging and multifamily owners and developers are experiencing financial challenges as well. 

In most U.S. apartment markets, rental rates are down 2% or 3%, Pumper pointed out. “Their occupancy, which used to be 92% or 93%, is dropping to 80 or 89. And concessions are coming back, in some cases as much as two to three months of a one-year lease.” 

Inventories of new apartment deliveries can also pose a problem, notably in the Sun Belt states. “All the places you want to own are getting overbuilt,” said Pumper.  

Spaugh drew a parallel between office owners that have staked a claim in the current market and retail landlords that have overcome the risk of obsolescence. “The [office] owners that got ahead of it were the ones that made their amenities better,” he said. “You take that lobby, you make it something nice. You put in a brewpub or something for the young people. Same with retail: the ones that have gotten ahead of it and have adjusted to the times are going to do better. And not everybody’s done that.” 

On the hotel side, Unell said, “We have a good number of hospitality assets in our portfolio and it’s a little bit of a mixed bag. On the ones that have come in in the last 24 months, we’ve had some good resolutions on a few of them.  

“But we have a couple that were really struggling,” she continued. “Those are going to end up being pretty big losses and they’re CBD hotels. That’s where the problem areas are.” 

The afternoon-long event also presented discussions on Fannie Mae and Freddie Mac, opportunistic capital and the current investment sales market. Check back later this week for more coverage. 

The largest U.S. banks remain in the best position to weather further loan performance declines for office and multifamily, two commercial real estate sectors that Fitch Ratings cites as having different trajectories compared to other property types. Although the drop in office loan performance represents a long-term structural shift in demand with loss rates yet to peak, multifamily declines appear more cyclical, according to group credit officer Julie Solar. Distress in both sectors has yet to play out, though.

“Migration into non-performing loans has been more muted for multifamily in comparison to office, but the upward trend represents a change for a category that had proven extremely stable over time,” said Solar. “Decreasing inflationary pressures, particularly insurance costs, and rental rate increases would provide relief to some troubled multifamily borrowers, while potential rate cuts would be especially beneficial in the rent-controlled space.”

Despite holding a majority of CRE loan balances, larger banks are much more diversified and better positioned to withstand expected credit deterioration, particularly in office loans. While the largest banks account for over half of non-performing CRE loans as of June 30, those banks with assets between $100 billion and $250 billion have a higher percentage of problem loans, according to Fitch.

The rating agency noted that office vacancies are also worse than multifamily, with an estimated 14% of office real estate vacant versus around 8% for multifamily. Large regional banks have both the most problem multifamily loans and the highest percentage of multifamily NPLs at 1.68%

Kroll Bond Rating Agency said the delinquency rate among KBRA-rated U.S. CMBS in August declined marginally to 4.98%, down 11 basis points from July. However, the CMBS distress rate–the total delinquent and specially serviced loan rate–increased 32 bps to 8.36%.

In August, CMBS loans totaling $1.7 billion were newly added to the distress rate, of which 64.6% was due to imminent or actual maturity default. The office sector experienced the highest volume of newly distressed loans (54.5%, $928.8 million), followed by multifamily at 29.4% ($500.7 million) and retail at 11.9% ($203 million).

Although on a dollar basis office was far and away the leading sector for new CMBS distress this month, KBRA said multifamily saw the largest distress rate increase: 100 bps after declining 110 bps in July. The increase included the addition of 20 Broad St. ($220 million in the $1.6-billion Hamlet 2020-CRE1) as a newly specially serviced loan, as well as six loans totaling $141.8 million that were delinquent in June and brought current in July, but which subsequently transferred to special servicing.

Pictured: 20 Broad St. in Manhattan’s Financial District. Photo courtesy of ATTCK.

The distress rate on apartment loans with CMBS financing has increased 185% year to date, according to CRED iQ. Loans in the multifamily sector began 2024 with a 2.6% distress rate—a composite of the special servicing and delinquency rates—and now stand at 7.4%.  

Although the monthly increase between May and June was a modest three basis points, apartment loans are now vying with those in lodging sector for third place, CRED iQ reported. 

The retail and office sectors are nearly neck-and-neck for the highest distress rates, notching 11.7% and 11.5%, respectively. Both sectors saw modest increases of four bps compared to the previous month.  

Hotels retained third place with an 8.1% distress rate, after logging the best month-over-month improvement of the group, with a 130-bp decline in distress. Industrial and self-storage continued operating at sub-1% in all but one of the past 7 months.    

The overall CRED iQ distress rate added 13 bps in June to 8.62%, nearly identical to May’s increase. The June rate a fourth straight record high. CRED iQ’s special servicing rate remained mostly flat at 8.08% while the CRED iQ delinquency rate gained 48 basis points to 6.28%. 

Although the much-anticipated wave of office distress has yet to materialize, new research from
Yardi Matrix shows that many markets are exposed to potential distress. The firm said debt service coverage ratios have declined for office properties in recent years, due to the two components of the ratio moving in opposite directions.

“As interest rates shot upwards in the last year-and-a-half, so did debt costs for commercial
real estate,” according to the Yardi Matrix report. “At the same time, cash flow has fallen—vacancy rates spiked as firms downsized or eliminated physical office footprints altogether—and expenses have grown.”

However, despite DSCRs’ downward movement, market-level average ratios show only a handful of markets exposed to widespread risk. In March, five of the 91 markets analyzed by Yardi Matrix had average DSCRs below 1.0: Brooklyn (0.81), Oklahoma City (0.89), Chicago (0.90), El Paso (0.92) and Cleveland (0.96). Another eight markets—including Manhattan (1.05), St. Louis (1.16) and Nashville (1.25)—sit at or below the 1.25 ratio required by most lenders.

The report points out, though, that “these market-level rates are only estimates, and DSCRs can vary vastly from property to property. Many properties within markets with low average DSCRs continue to perform well, while properties in markets with a high average DSCR face distress.”

Although delinquencies for CMBS backed by retail loans reached heights that were exceeded only by those of the lodging sector during the pandemic, since then retail CMBS has improved in a number of metrics, reported Trepp. March’s overall decline in the CMBS delinquency rate was led by retail, which saw a 47-basis-point decrease to 5.56%. 

“This comes even as the outstanding balance of retail loans has remained relatively flat, indicating resilience in issuance amid softening performance,” wrote Trepp’s Thomas Taylor. 

In mid-2020, the percentage of retail-backed CMBS loans reached 28.8%, compared to the pandemic-era peak of 25.7% for all loans. As of March 2024, 24.9% of all loans are on watchlists, up 199 bps month-over-month, compared to 19.6% of retail loans, which saw a 22-bp monthly increase. 

“As of March 2024, retail remains the second-worst performing asset by delinquency and special servicing rate (only outpaced by office in both), while it boasts the lowest watchlist rate,” wrote Taylor. Driving retail’s overall performance in delinquency and special servicing are loans backed by regional malls, while loans tied to superregional, neighborhood and community shopping centers are performing relatively well. 

However, Taylor reported, “retail’s distress metrics continue to improve monthly,” with delinquencies down 129 bps year-to-date, and it remains the third-largest securitized asset class by balance. It’s topped only by office and multifamily, both of which are seeing worsening distress metrics, with delinquencies up by 482 bps and 227 bps YTD, respectively.