NEW YORK CITY – Commercial real estate collateralized loan obligations, known as CRE CLOs, are facing significant challenges as borrowers struggle to repay loans linked to risky real estate ventures. These investment products bundle speculative debt into bonds of varying risk and return. In recent months, the troubled assets held by CRE CLOs have surged, causing delinquency rates to reach double digits and leading major players in the $80 billion market to rework loans.
The CRE CLO market is experiencing unprecedented stress due to the nature of the loans it holds, primarily short-term, floating-rate loans for properties undergoing renovations or expansions. With rising interest rates affecting property prices and demand for office space still weak, many borrowers are finding it difficult to meet their financial obligations. As a result, CRE CLO issuers are facing losses and struggling to maintain the integrity of their structures.
Industry experts note that the CRE CLO market is vulnerable to defaults, with lenders relying on the resale of transitional properties before loan maturity. While the highest rated debt in CRE CLOs is considered secure, the riskiest portions are facing challenges. Issuers are seeking ways to mitigate risks by extending maturities, restructuring loans, and buying out delinquent loans to avoid asset-coverage tests.
The pandemic created ideal conditions for a surge in CRE CLO issuance in 2021 as real estate investors took advantage of short-term loans for property investments. However, as interest rates rise and the demand for rental properties shifts, developers who relied on “fix and flip” strategies are encountering difficulties. The share of delinquent loans in CRE CLOs has increased, putting issuers like Arbor Realty Trust and Ready Capital under pressure.
Recent downgrades of CRE CLO bonds issued by Blackstone Mortgage Trust highlight the challenges faced by the market, particularly in the office sector. Short sellers have raised concerns about potential losses in the industry, likening the situation to the pre-financial crisis era. As the market continues to undergo stress testing, industry experts emphasize the need for CRE CLO sponsors to demonstrate resilience in the face of adversity.