Office CMBS Delinquency Hits All-Time High: Surpassing Financial Crisis Woes!

The office debt crisis is spiraling out of control! In 2024, the mantra was “Survive till 2025” with a strategy of extend-and-pretend. But what’s next?

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Brace yourselves: the delinquency rate for office mortgages bundled into commercial mortgage-backed securities (CMBS) has skyrocketed to a staggering 11.0% as of December—a record-setting high that eclipses even the turmoil of the Financial Crisis, where rates peaked at 10.7%. This alarming statistic, provided by industry analysts, reveals a bleak reality for the office sector.

In just two years, the delinquency rate has ballooned by a jaw-dropping 9.4 percentage points, moving from a seemingly stable 1.6% to a dismal 11.0%. What once seemed secure has plummeted into chaos.

This once-thriving office sector is now in the grips of a depression as the tide of office debt rises relentlessly, with an additional $2 billion in office CMBS becoming newly delinquent in December alone.

When it comes to commercial real estate (CRE), office debt is the canary in the coal mine. With a staggering CMBS delinquency rate of 11.0%, it stands in stark contrast to lodging (6.1%), struggling retail (7.4%), and multifamily properties (4.6%). Meanwhile, industrial properties like warehouses and fulfillment centers continue to thrive, boasting a mere 0.3% delinquency rate, thanks to the ongoing e-commerce boom.

The office market is experiencing a dramatic divide. High vacancy rates in new, state-of-the-art buildings are prompting companies to flee older towers for more modern accommodations, all while downsizing their office space. As they vacate these outdated buildings, finding new tenants becomes increasingly difficult—sending vacancy rates soaring and accelerating their decline. It’s the older office towers that are in the hot seat, not their sleek, contemporary counterparts.

Delinquency is defined when landlords fail to make their interest payments after a 30-day grace period. If a landlord keeps up with interest but doesn’t pay the loan when it matures, that’s a repayment default—not technically delinquent. If we factored in these repayment defaults, the delinquency rate would be even worse.

Loans come off the delinquency list when interest is paid, the property is foreclosed, or when a deal is struck between landlords and the special servicer representing the CMBS holders, often through painful restructures—a classic case of “extend-and-pretend.”

Extend-and-pretend has been the buzzword of 2024, dragging these issues into 2025. This strategy may help lenders navigate a temporary storm, but it can’t solve structural problems that run deep.

With the motto “survive till 2025,” many believed the structural issues plaguing office CRE would magically vanish as the Federal Reserve cut interest rates back to zero. But spoiler alert: that’s not happening.

The fundamental problem is clear: there’s simply too much office space. Many landlords are defaulting on interest payments because they can’t collect enough rent from their half-empty buildings. Refinancing maturing loans is nearly impossible when income doesn’t cover costs, and selling these older towers is out of the question, as their values have plummeted by as much as 50%, 60%, or even 70%—in some cases, they’re only worth the land they sit on.

The glut of office space stems from years of overbuilding, fueled by a speculative “office shortage” narrative that had companies eagerly securing more space than they ever needed. When the pandemic hit, it became crystal clear—they didn’t need all that unused office space. Now, they’re flooding the market with subleases, compounding the glut.

The Fed has cut interest rates by 100 basis points, yet in December, it projected only a modest 50 basis points of cuts for 2025 and hinted that there’s still “work to do” as inflation re-accelerates and the economy outpaces its long-term average.

Many CRE loans are floating-rate, linked to short-term rates like SOFR, meaning while lower short-term rates provide some relief, they won’t resolve the fundamental overcapacity of office space. Owners of nearly empty older towers will still struggle to make interest payments even with reduced rates.

A silver lining for US banks is that a significant portion of office mortgages is distributed across a diverse array of investors globally, including bond funds, pension funds, insurers, and foreign banks. This means they pose little threat to the stability of the US banking system.

However, US banks also hold a significant amount of office loans, with some already reporting hefty write-downs. While the situation is being cleaned up, many troubled mortgages were extended in 2024, and as 2025 looms, regulators are losing patience with the extend-and-pretend strategy.

Write-downs on office debt can severely impact earnings, leading to stock price declines. While smaller banks may stumble under the weight of their office debt, a collapse hasn’t occurred yet.

Despite the challenges, office debt alone isn’t substantial enough to cause major disruptions—it comprises less than $1 trillion, or about 16% of total CRE debt—and is held too broadly by investors to wreak havoc on the US banking system.

Converting offices to residential spaces is viable for only a select number of towers. For more insights and figures, dive into the comments below.

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