2023 Q4 Databook
April 2, 2024
Jamie Woodwell; Reggie Booker
ECONOMY
The U.S. economy ended 2023 on a strong note and has remained more resilient than many had anticipated.
The gross domestic product grew at a seasonally adjusted annual rate of 3.4 percent in the fourth quarter, down from 4.9 percent in Q3 but otherwise the strongest showing since the end of 2021. Consumer expenditures remained robust, with spending on goods growing at a real rate of 3.2 percent per year and spending on services growing by 2.8 percent.
The job market has been equally steady, adding a seasonally adjusted average of 212,000 jobs per month during Q4 and 229,000 in January and 275,000 in February. While viewed as a less reliable gauge than the establishment survey that provides the numbers above, the household survey has shown a declining number of employed workers in recent months, contributing to an uptick in the unemployment rate to 3.9 percent in February after three months at 3.7 percent.
The still tight labor market has helped elevate hourly earnings 4.3 percent higher than they were a year ago. The drop-off in headline inflation to 3.2 percent in February (from its January 2022 peak of 9.2 percent) means that earnings growth is once again outpacing the rise in prices.
Balancing inflation, labor market strength and the Fed Funds Rate, which they have held steady since last summer, the Federal Reserve continues to signal patience and a focus on incoming data. Ten-year Treasury yields have spent most of this year above four percent while SOFR has spent it above 5 percent.
PROPERTY FUNDAMENTALS
Commercial property markets are dynamic, with different property types moving in different directions, and significant variation by property type and subtype, market and submarket, quality, vintage and more.
Office
In September 2022, we wrote a white paper looking into office demand in a post-pandemic world. The paper started: “Work-from-home has brought an existential question to the office market. Two-and-a-half-years into the pandemic, with office properties currently at 40 percent of their pre-pandemic occupancy, what’s ahead for the sector?”
Now, another year-and-a-half later, that question remains largely unanswered, although we are starting to see some trends. Offices have seen an uptick in usage, particularly mid-week, with significant variation between markets and submarkets. And location and property quality definitely matter. In a recent note, JP Morgan noted, “Focusing on the NYC office market and using a sample of SASB office properties, we estimate that workers are returning to the office at a rate of 78% of their 2019 levels and workers are commuting to the office more during the middle of the week. Additionally, people who work in the Times Square neighborhood are returning to work at a higher rate relative to those who work in other NYC neighborhoods.”
We are starting to more clearly delineate the “survivors” – buildings that are attracting new leases and owners that are investing in the TI and other elements of keeping a building going. Those buildings will attract capital, and with it new tenants. As other buildings and owners struggle, the universe of available office space will decline, bringing greater balance.
Retail
As we’ve noted before, there are certain similarities between where the office market is today and where retail was a number of years ago. Questions about the future of malls and a general “over-retailing” of the United States cast a pall over investing and lending on retail properties. Consistent economic growth and the strength of the consumer has turned that narrative around. Retail is now among the more favored property types.
JLL’s Q4 Retail Outlook noted, “Retail net absorption surged 37.2% quarter-over-quarter to 17.6 million s.f. – boosted by a significant jump in mall net absorption. Conversely, deliveries decreased 5.1% from the previous quarter. With little new construction and rising absorption, vacancy fell 20 basis points to 4.0% - the lowest on record since 2007.”
Apartment
After a number of years of demand significantly outstripping the supply of apartments, developers ramped up building activity and the reverse is now true. An annualized pace of more than 500,000 multifamily units were delivered in December and January, compared to just more than 350,000 delivered in 2022. And there remain nearly one million more units currently under construction.
That new supply has brought the multifamily rental vacancy rate from 6.5 percent at the end of 2022 to 7.7 percent as of the end of 2023. Following the dictates of Econ 101, the rent pressure we saw when demand exceeded supply has softened. A new series from the Bureau of Labor Statistics that track the rents paid by newly signed tenants showed those asking rents in Q4 2023 declined 4 percent from a year earlier. Because rents of in-place tenants were still catching up to the previous increases, Q4 rents for all tenants increased 5.3 percent from a year earlier.
The moderation in rent growth will bring relief to many tenants and potential challenges to some owners whose expenses outpace income growth. It is also unlikely to significantly aid the many renter households whose incomes are below what it costs to build and maintain housing and who depend on some form of subsidy to make up the gap.
Industrial
Industrial market dynamics are – in broad terms – similar to those in multifamily. The onset of the pandemic led to a surge in demand that easily exceeded existing supply – driving vacancies lower and rents higher. Strong new development followed, bringing with it higher vacancy rates and more stability to rents. That, in turn, has slowed the development pipeline. On their Q4 earnings call, Prologis noted, “In closing, we know that the market is not yet out of the woods with regards to incoming supply, but the combination of a stronger backdrop, continued low level of starts, and a calmer capital markets environment has us optimistic that 2024 will be another great year.”
PROPERTY SALES
Sales of commercial real estate properties remained subdued during the Fourth Quarter, capping a year of subpar activity. Sales activity in Q4 was 38 percent lower than a year-earlier and down 51 percent for the year as a whole. The slower decline in Q4 is less a sign of market improvement and more the mathematical results of the fact that Q4 2022 had already seen a significant slide from previous quarters.
Counter to what one might conclude from the headlines, the drop-off in sales was not all about office properties. Yes, sales of office properties slid 56 percent from 2022 to 2023, but sales of retail properties fell 38 percent, industrial fell 44 percent, hotel fell 47 percent and apartments fell 61percent.
The lack of sales transactions continues to leave a blindspot on property valuations, with different price indexes showing different results. A CRE price index used by the Federal Reserve reported a 6 percent value decline during Q4 2023, bringing values 9 percent lower than their recent peak. Green Street also reported a 6 percent Q4 decline, but with values now 22 percent lower than peak. MSCI’s Real Capital Analytics CPPI reported property values were flat during Q4 2023 and down 11 percent from peak. Until sales activity picks up, it is likely the various price indexes will continue to have a muddy view into values.
MORTGAGE ORIGINATIONS
Borrowing and lending backed by commercial real estate remained subdued to close out 2023. The fourth quarter saw a small pick-up from the previous quarter, as is usually the case, but was still down about 25 percent from 2022’s already suppressed fourth-quarter pace. For the year, mortgage originations were about 50 percent below 2022 levels, with every major property type and capital source experiencing a decline.
Commercial and multifamily mortgage loan originations were 25 percent lower in the fourth quarter of 2023 compared to a year earlier and increased 13 percent from the third quarter of 2023.
Decreases in originations for office, heath care, multifamily, and industrial properties led the overall drop in commercial lending volumes when compared to the fourth quarter of 2022. There was a 68 percent year-over-year decrease in the dollar volume of loans for office properties, a 39 percent decrease for health care properties, a 27 percent decrease for multifamily properties, and a 7 percent decrease for industrial properties. Retail properties increased 50 percent, and hotel property loan originations increased 81 percent, respectively, compared to the fourth quarter of 2022.
Among investor types, the dollar volume of loans originated for depositories decreased by 53 percent year-over-year. There was a 29 percent decrease for government sponsored enterprises (GSEs – Fannie Mae and Freddie Mac) loans, a 6 percent decrease in life insurance company loans, and a one percent decrease for investor-driven lender loans. There was a 144 percent increase in the dollar volume of commercial mortgage-backed securities (CMBS) loans.
MORTGAGE MATURITIES
The lack of transactions and other activity last year, coupled with built-in extension options and lender and servicer flexibility, has meant that many loans that were set to mature in 2023 have been extended or otherwise modified and will now mature in 2024, 2026, 2028 or in other coming years, These extensions and modifications have pushed the amount of CRE mortgages maturing this year from $659 billion to $929 billion.
The loan maturities vary significantly by investor and property type groups. Just $28 billion (3 percent) of the outstanding balance of multifamily and health care mortgages held or guaranteed by Fannie Mae, Freddie Mac, FHA and Ginnie Mae will mature in 2024. Life insurance companies will see $59 billion (8 percent) of their outstanding mortgage balances mature in 2024. By contrast, $441 billion (25 percent) of the outstanding balance of mortgages held by depositories, $234 billion (31 percent) in CMBS, CLOs or other ABS and $168 billion (36 percent) of the mortgages held by credit companies, in warehouse or by other lenders will mature in 2024.
By property type, 12 percent of mortgages backed by multifamily properties will mature in 2024, as will 17 percent of those backed by retail and 18 percent for healthcare properties. Among loans backed by office properties, 25 percent will come due in 2024, as will 27 percent of industrial loans and 38 percent of hotel/motel loans.
Commercial mortgages tend to be relatively long-lived, spreading maturities out over several years. Volatility and uncertainty around interest rates, a lack of clarity on property values, and questions about some property fundamentals have suppressed sales and financing transactions. This year’s maturities, coupled with greater clarity in those and other areas, should begin to break the logjam in the markets.
MORTGAGE DEBT OUTSTANDING
The amount of commercial mortgage debt outstanding grew in the final quarter of 2023 and for the year as a whole. However, the increase was among the slowest paces since the mid-2010s.
Total mortgage debt outstanding rose by 0.9 percent ($41.8 billion) to $4.69 trillion in the fourth-quarter of 2023. Multifamily mortgage debt grew by $25.0 billion (1.2 percent) to $2.09 trillion during the fourth quarter.
Commercial banks continue to hold the largest share (38 percent) of commercial mortgages at $1.8 trillion. Agency and GSE portfolios and MBS are the second largest holders of commercial/multifamily mortgages, at $1.0 trillion (21 percent of the total). Life insurance companies hold $733 billion (16 percent), and CMBS, CDO and other ABS issues hold $593 billion (13 percent).
Looking solely at multifamily mortgages, agency and GSE portfolios and MBS hold the largest share of total debt outstanding at $1.0 trillion (48 percent of the total), followed by commercial banks with $612 billion (29 percent), life insurance companies with $235 billion (11 percent), state and local governments with $116 billion (6 percent), and CMBS, CDO and other ABS issues with $67 billion (3 percent).
Every major capital source increased its mortgage holdings during the year. Mortgage originations were down by roughly 50 percent in 2023 compared to 2022, but that meant that few loans were paying off, helping maintain portfolio sizes even in the face of lower inflows.
LOAN PERFORMANCE
Ongoing challenges in commercial real estate markets pushed the delinquency rate on CRE-backed loans higher in the final three months of 2023. Delinquency rates jumped to 6.5 percent of balances for loans backed by office properties and to 6.1 percent for lodging-backed loans. Delinquencies for loans backed by retail properties remain elevated from the onset of the pandemic but were unchanged during the quarter. Delinquency rates for multifamily and industrial property loans both increased marginally but remain much lower.
- 96.8% of outstanding loan balances were current or less than 30 days late at the end of the third quarter, down from 97.3% at the end of the third quarter of 2023.
- 2.3% were 90+ days delinquent or in REO, up from 2.2% the previous quarter.
- 0.3% were 60-90 days delinquent, up from 0.2% the previous quarter.
- 0.6% were 30-60 days delinquent, up from 0.3%.
- Loans backed by office properties drove the increase.
- 6.5% of the balance of office property loan balances were 30 days or more days delinquent, up from 5.1% at the end of last quarter.
- 6.1% of the balance of lodging loans were delinquent, up from 4.9%.
- 5.0% of retail balances were delinquent, flat from the previous quarter.
- 1.2% of multifamily balances were delinquent, up from 0.9%.
- 0.9% of the balance of industrial property loans were delinquent, up from 0.6%.
Every major capital source has seen an increase over the last six months, as higher interest rates, uncertainty about property values, and challenges in some property fundamentals work their way through the markets.
Based on the unpaid principal balance (UPB) of loans, delinquency rates for each group at the end of the fourth quarter of 2023 were as follows:
- Banks and thrifts (90 or more days delinquent or in non-accrual): 0.94 percent, an increase of 0.09 percentage points from the third quarter of 2023;
- Life company portfolios (60 or more days delinquent): 0.36 percent, an increase of 0.04 percentage points from the third quarter of 2023;
- Fannie Mae (60 or more days delinquent): 0.46 percent, a decrease of 0.08 percentage points from the third quarter of 2023;
- Freddie Mac (60 or more days delinquent): 0.28 percent, an increase of 0.04 percentage points from the third quarter of 2023; and
- CMBS (30 or more days delinquent or in REO): 4.30 percent, an increase of 0.04 percentage points from the third quarter of 2023.
Long-term interest rates have come down from their highs of last year, which should provide some relief to some loans, but many properties and loans still face higher rates, uncertainty about property values and – for some properties – changes in fundamentals. Each loan and property faces a different set of circumstances, which will come into play as the market works through loans that mature this year.