2023 Q1 Databook

July 1, 2023 Jamie Woodwell; Reggie Booker

The U.S. economy has slowed, but less than many expected, to start 2023. Tighter credit conditions and an inverted yield curve serve as signs that further slowdowns may be ahead.

Inflation-adjusted gross domestic product grew at a seasonally adjusted annual rate of 2.0 percent in Q1, down from 2.6 percent in Q4 2022 and 3.2 percent in Q3 2022.  Consumers remain a key driver of that growth, with consumer expenditures on goods rising at a real annualized rate of 6.0 percent and on services at 3.2 percent during the quarter.  That offset declines in other areas such as residential investment and business equipment.

The labor market has also remained strong but with additional signs of potential loosening.  Businesses added 742,000 jobs in January, 248,000 in February, 217,000 in March, 294,000 in April, and 339,000 in May.  It’s important to note that a separate survey of households by the same Bureau of Labor Statistics showed 310,000 fewer people employed in May than the month before.  This latter result led to a rise in the unemployment rate from an all-time low of 3.4 percent in April to 3.7 percent in May – still very low by historical standards.  The tight labor conditions have kept wage growth strong, with average hourly earnings 4.3 percent higher in May than a year earlier, down from a growth rate of 5.5 percent a year earlier.

Wage growth is one of the factors weighing on the Federal Reserve as it works to bring down the rate of inflation.  Consumer Price Index (CPI) data shows prices increased 4.0 percent between May 2022 and May 2023, less than half the rate of inflation of a year earlier but still double the Fed’s preferred rate.  Core inflation (excluding food and energy items) rose 5.3 percent, compared to 6.0 percent a year earlier.  Shelter costs, including rent, remain a key driver of overall price increases – with in-place rents measured by the CPI rising 8.7 percent between May 2021 and May 2022.  Recent moderation in asking rents seems to signal those in-place rents may also begin to moderate.

Responding to a mix of signals – a slowing but still higher than hoped for rate of inflation, a tight labor market with signs of potential softening, three large bank failures in the Spring -- the Federal Reserve raised the Fed Funds Rate again in May and chose to pause, or perhaps skip, at its June meeting.  Projections and comments from the meeting challenged market expectations that the Fed would begin lowering rates later this year, putting upward pressure on both shorter and longer-term rates.

Commercial real estate markets have been feeling the effects of higher mortgage rates, uncertainty about property values and questions about some property fundamentals since the middle of last year, but the recent bank failures have brought heightened attention, to the point that at the most recent meeting of the Financial Stability Oversight Council commercial real estate was a featured topic.

OFFICE: Among different property types, offices continue to attract the greatest scrutiny.  Various measures show that hybrid work has gained a strong foothold.  One closely watched gauge, Kastle System’s record of employee “swipes” to enter offices, shows office usage at roughly half of pre-pandemic levels, but with significant variation by day (ranging from 33 percent of pre-pandemic levels on Fridays to 60 percent on Tuesdays) and market (with San Jose at 45 percent of pre-pandemic levels on Tuesdays and Chicago and Houston at 69 percent).  Some other measures, including cell phone tracking and transit usage, imply a greater level of return to the office.  Changes in, and uncertainty about, office usage have led to a run-up in office vacancies, hitting 19.0 percent in Q1 from 18.1 percent a year earlier.  This generally does not include space available for sublease which can drive that number higher.  While many of the headlines highlight the hardest-hit properties, market participants appear to be beginning to differentiate between properties that are being significantly impacted and those that are not.

RETAIL: Retail space, which had been the property type of greatest concern even before the pandemic, continues to stabilize, particularly with an appreciation of the different subtypes of space.   In the aggregate, retail vacancies declined 10 basis points over the year, from 10.4 percent to 10.3 percent according to Moody’s.  Within that, there are significant variations, with strength among general retail and neighborhood and strip centers.  Consumers continue to increase spending, with the Census Bureau showing overall retail sales increasing 3.4 percent over the last year, driven by a 7.8 percent rise in e-commerce sales and 2.7 percent rise in bricks-and-mortar.

INDUSTRIAL: The industrial market remains extremely tight, with vacancy rates in 2022 at 3.6 percent, down from 5.8 percent in 2021. New supply is outpacing absorption for the first time in years leading to a slight uptick in availability, but the rapid rise in rents in recent years means there is considerable upside for properties with expiring leases.  In their Q1 earnings statement, Prologis reported occupancy of 98 percent and same-store net effective NOI growth of 9.9 percent over the prior year.

APARTMENT: Apartment markets have been similarly tight in recent years, leading to record low vacancy rates and strong rent growth.  Conditions began to shift at the end of 2022, particularly in markets with strong deliveries.  Vacancy rates increased in Q1 by 20 basis points from a year earlier, to 4.9 percent.  Some series showed rent declines during the slow winter leasing months, and at least a slowdown from the double-digit rent growth of 2022.  There are nearly one million multifamily units currently under construction, with a typical start-to-completion time of 18 months for properties with 20 or more units.  While permitting and starts have remained robust in recent months, there are some expectations that higher interest rates and a tightening of lending may constrain future starts and, eventually, new supply.

Commercial and multifamily property sales volumes in Q1 2023 were 54 percent lower than during the first quarter of 2022, with declines across all property types – Office down 68 percent, apartments down 64 percent, hotels down 55 percent, industrial down 54 percent and retail down 27 percent according to MSCI.  

The lack of transaction volume means that many measures of pricing are likely lagging what is happening in the market.  The Green Street Advisors commercial property price index shows Q1 values down 15 percent from recent highs while the Real Capital Analytics CPPI shows a 10 percent decline.  A similar lag is likely taking place in many cap rate measures.  

As transaction volume picks-up, likely driven by maturing loans, we should start to get more insights into current values, although it is also likely that the transactions we see will be biased toward properties that are forced to transact, and therefore may not be representative of the wide range of commercial and multifamily properties in the market.

While the first quarter is typically the quietest period of the year, borrowing and lending backed by commercial and multifamily properties declined in the first quarter to the slowest pace since the first quarter of 2014. Uncertainty and volatility with regard to interest rates and property values, and supply and demand imbalances for some property types, has led to a logjam in commercial real estate sales and financing markets.

As loans mature and adjustable-rate loans reset, we should start to get greater insights into where things stand.

Commercial and multifamily mortgage loan originations were 56 percent lower in the first quarter of 2023 compared to a year ago and decreased 42 percent from the fourth quarter of 2022.

Decreases in originations for all major property types led to the overall drop in commercial/multifamily lending volumes when compared to the first quarter of 2022. There was a 72 percent year-over-year decrease in the dollar volume of loans for industrial properties, a 69 percent decrease for health care properties, a 67 percent decrease for office properties, a 55 percent decrease for multifamily properties, an 8 percent decrease for hotel properties, and an 8 percent decrease for retail properties.

Among investor types, the dollar volume of loans originated for life insurance company loans decreased by 73 percent year-over-year. There was a 67 percent decrease for investor-driven lenders, a 59 percent decrease in commercial mortgage-backed securities (CMBS) loans, a 54 percent decrease for depositories, and a 14 percent decrease in the dollar volume of government sponsored enterprises (GSEs – Fannie Mae and Freddie Mac) loans.

The changes in commercial and multifamily mortgage debt outstanding reported in this quarter’s analysis should be used with caution.  The bank numbers are heavily influenced by the FDIC’s take-over of certain multifamily and other mortgages formerly held by Signature Bank.  Those loans are accounted for in the bank and total figures for Q4 2022 but likely not in the total or federal government figures for Q1 2023.  Similarly, it appears some of changes seen in multifamily totals for CMBS may be the result of how the Federal Reserve identifies the ‘holder’ of certain assets rather than any changes in the actual amount of loans outstanding.  We will be working through these issues and amending data as appropriate in future releases.

Commercial banks continue to hold the largest share (38 percent) of commercial/multifamily mortgages at $1.7 trillion. Agency and GSE portfolios and MBS are the second-largest holders of commercial/multifamily mortgages (21 percent) at $957 billion. Life insurance companies hold $680 billion (15 percent), and CMBS, CDO and other ABS issues hold $597 billion (13 percent). 

Looking solely at multifamily mortgages in the first quarter of 2023, agency and GSE portfolios and MBS hold the largest share of total multifamily debt outstanding at $957 billion (48 percent), followed by banks and thrifts with $593 billion (30 percent), life insurance companies with $215 billion (11 percent), state and local government with $113 billion (6 percent), and CMBS, CDO and other ABS issues holding $66 billion (3 percent).  

At MBA’s CREF Convention, we released the results of our annual survey of upcoming commercial and multifamily mortgage maturities.  The survey collects information directly from loan servicers on when the loans they service mature.  As in past years, the numbers we released covered loans held by non-bank lenders – including those guaranteed by Fannie Mae, Freddie Mac, and FHA, as well as those held by life companies, included in commercial mortgage-backed securities (CMBS), made by investor-driven lenders like debt-funds, mortgage REITs, and other credit companies.  While the information we collect covers essentially all the loans in those groups, it has typically covered only a sample of loans held by banks.

This year’s survey, however, collected information on $400 billion of bank-held commercial and multifamily mortgages – 23 percent of the outstanding universe.  Using this year’s survey results, for the first time we are expanding our loan maturity analysis to include an estimate of the maturity profile of all commercial and multifamily mortgages – including the more than $1.7 trillion on bank balance sheets.

The analysis estimates that of approximately $4.4 trillion of outstanding commercial/multifamily mortgages, $728 billion (16%) matures in 2023 with another $659 billion (15%) maturing in 2024.  Within hotels/motels loans, 34 percent of the outstanding balance is maturing this year -- the largest share of property-type specific loans maturing in 2023 – followed by office, with 25% of outstanding office loans maturing in 2023.  Multifamily is the property type with the smallest share of outstanding mortgages maturing this year, (9%).

Among capital sources, 26 percent of the outstanding balance of loans held by credit companies and other investor-driven lenders will mature this year, as will 23 percent of the balances held by depositories and 22 percent held in CMBS.  Only 7 percent of life company loans and 2 percent of GSE/FHA loans come due this year.

It is these maturities – weighted toward office loans and loans with shorter-terms – that are likely to drive transactions as the year progresses.

Out of $4.5 trillion of commercial and multifamily mortgage debt outstanding, multifamily accounts for nearly half—$2 trillion—followed by office—at $750 billion or 17 percent of the total. 

Of that $750 billion of office-backed mortgages, we estimate that $339 billion is held by banks. That is 45 percent of all office-backed loans, 20 percent of all bank-held commercial and multifamily mortgages, and 8 percent of all commercial and multifamily mortgages.

Of that $339 billion of bank-held office-backed mortgages, $98 billion matures in 2023. That is 29 percent of all bank-held office-backed loans, 13 percent of all office-backed loans, 6 percent of all bank-held commercial and multifamily mortgages, and 2 percent of all commercial and multifamily mortgages.

Ongoing stress caused by higher interest rates, uncertainty around property values and questions about fundamentals in some property markets are beginning to show up in commercial mortgage delinquency rates.

Given differences in their structures, each major capital source tracks delinquencies slightly differently – making them incomparable on an absolute level.  Even so, delinquency rates increased for every major capital source during the first quarter, foreshadowing additional strains that are likely to work their way through the system. Among bank-held loans, the 30+ day commercial/multifamily mortgage delinquency rate increased from 0.45 percent at the end of Q4 2022 to 0.58 percent at the end of Q1 2023.  Freddie Mac’s 60+ day delinquency rate rose from 0.12 percent to 0.13 percent and Fannie Mae’s from 0.24 percent to 0.35 percent (Note that even Freddie and Fannie track delinquencies slightly differently). Life companies’ 60+ day commercial mortgage delinquencies rose from 0.11 percent to 0.21 percent.  And among CMBS loans, the 30+ day delinquency rate, including loans in foreclosure and REO, rose from 2.90 percent to 3.00 percent.

For most capital sources, delinquency rates remain low by historical standards. But with 16 percent of outstanding loan balances facing loan maturities this year, the first edge of properties is just beginning to be pushed to adjust to today’s markets – with higher interest rates, uncertain property values, and questions about some property fundamentals.  As they do, delinquency rates are likely to continue to rise.