Commercial real estate gets even bleaker with $64 billion in property now classified as distressed

The amount of distressed assets rose 10% in the first three months of the year, according to a new report from MSCI Real Assets. Risks loom on the horizon too, with nearly $155 billion of commercial property assets that are potentially troubled, according to the report. 

Higher borrowing costs have pummeled the commercial real estate industry, driving prices lower and causing some owners to choose to default. Much of the potential distress is tied to buildings that need refinancing at a time when lenders are tightening credit following the collapse of several regional banks.

“Should this potential distress be upgraded to full-blown trouble, an increase in distressed asset sales and declining prices would be inevitable,” MSCI Real Assets researchers including Jim Costello and Alexis Maltin wrote in the report.

Retail properties including malls were the most troubled type of real estate, with nearly $23 billion of distressed assets tied to the sector. About $18 billion of office buildings were considered distressed at the end of March, according to the report. 

Offices, which are also struggling with weaker demand given the rise in remote work and job cuts, account for nearly $43 billion of potential distress, the most of any sector. Offices face a bigger wave of maturing debt while distress in retail “appears to be cooling,” the report says.

Manhattan was the most active market for distressed asset sales, with $2.6 billion of deals — or 19% of US transactions — in the 12 months through May. Los Angeles ranked second with $746 million of deals, followed by Houston with $465 million of distressed transactions, according to MSCI Real Assets.

MSCI defines “distressed” as properties in bankruptcy, default, court administration, liquidation, with “significant tenant distress” or that have commercial mortgage-backed securities that have been transferred to a special servicer. Potentially distressed properties include real estate that faces delays in reselling or leasing or has debt that’s on a CMBS watchlist, is in forbearance, or is delinquent on payments.