US Commercial Real Estate Faces Repricing Risk as Debt Maturities Loom

The US commercial real estate (CRE) market is navigating a challenging landscape, with rising vacancy rates, declining valuations, and a looming maturity wall threatening to further weaken the sector, according to a note published by the Federal Reserve Bank of St. Louis on Thursday.

The note highlights the potential for increased financial stress and losses in the CRE market, which could have implications for the broader US economy.

The "maturity wall" in the CRE market refers to a large volume of commercial real estate loans that are scheduled to mature within a relatively short period. This creates a situation where borrowers need to refinance their loans at potentially higher interest rates, potentially impacting their financial obligations and the overall health of the CRE market.

Typically, CRE loans have shorter maturities and balloon payments, meaning the borrower is required to make a large lump-sum payment at maturity, representing the remaining principal balance. Rather than paying off this lump sum, borrowers typically seek to refinance their loans by obtaining a new loan with a new interest rate and maturity date, using the proceeds to pay off the existing loan. However, if interest rates have increased since the original loan was issued, as they have in the current macro environment, the borrower will need to refinance at a higher rate, leading to higher debt payments and potentially impacting their financial stability.

Industry estimates indicate that approximately $1.7 trillion, or nearly 30% of outstanding CRE debt, is expected to mature between 2024 and 2026. This significant volume of maturing loans, coupled with the recent rise in interest rates, poses a significant challenge for CRE borrowers and could lead to increased financial stress, potential defaults, and further decline in property valuations.

The note underscores the importance of monitoring CRE market conditions closely as loans mature, appraisals and sales resume, and price discovery takes place. The extent of losses for the market will depend on how these factors unfold.

The underlying market fundamentals are also softening. Net operating income (NOI) has come under pressure, particularly in the office sector, due to the combination of cyclical headwinds from higher interest rates and structural challenges from the rise of hybrid and remote work trends. Office vacancy rates have reached 19%, surpassing previous highs reached during the Great Recession and the COVID-19 recession, further indicating weakening demand for office space.

"The combination of elevated market rates, softening NOI and rising vacancy rates is starting to weigh on CRE valuations," the note states.

The CoStar Commercial Repeat Sales Index has declined 20% from its July 2022 peak, with the multifamily and office sectors experiencing the most significant declines. While some metrics suggest potential stabilization, further pressure on valuations could occur as sales volumes return and capitalization rates adjust upward.

The note emphasizes that the potential for losses in the CRE sector poses a risk to the banking system, particularly for institutions with high CRE concentrations. US banks hold a significant portion of CRE debt, making this a key area for continued monitoring.