Bonds backed by commercial real estate loans could be the next pain point for markets, economist says

• Delinquencies of loans backing CMBS have spiked, with the troubled office sector to blame.
• Trouble for CMBS bonds is a greater concern than banks' CRE exposure, David Rosenberg said.

Markets have been fretting over regional banks' exposure to troubled commercial real estate debt in recent months, but a bigger problem may be lurking in another corner of the property market.

Delinquencies for commercial mortgage-backed securities — bonds backed by loans on commercial properties — have spiked over the last year, with the office sector shouldering the blame as delinquency rates for office loans more than tripled since the start of 2023, David Rosenberg, president of Rosenberg Research, said in a note on Thursday.

Office values in major markets like San Francisco, Los Angeles, and New York have plunged due to rising vacancy rates driven by work-from-home dynamics. The influx of riskier interest-only loans that back CMBS has left holders exposed to this sharp decline in commercial property values, Rosenberg noted.

"While equity investors get sucked into the AI mania, there are real signs of stress in the economy, and this is just one of them. When everything looks perfect, it takes one event to burst the bubble, and multiple data points highlight that this is where the next contagion may be brewing," Rosenberg said.

Major US banks have been grappling with a surge in commercial mortgages over 30 days late, with total delinquencies on the debt surpassing reserves set aside to deal with loan losses.

Yet, Rosenberg notes that the CMBS market is the bigger problem, as investors are exposed directly to falling property values and poor loan performance. The total CMBS delinquency rate has risen from 2.94% in January 2023, to 4.66% in January this year. Even more stark has been the rise in the delinquency rate on office debt backing the bonds, which has gone from 1.86% to 6.3% in a year.

"This just goes to show that the scale of the problem, and what we are seeing so far in increased provisions by banks may just be the tip of the iceberg. The wave of CMBS defaults may be the next domino to fall for investors," Rosenberg added.