Street Talk | Season 2 | Ep.2 - Banks Tackle CRE Maturity Wall, But Rate Risks Loom

View Full Transcript

Tim Zawacki   00:00:00

Welcome to StreetTalk, the S&P Global Market Intelligence podcast that offers listeners a deep dive into the issues and developments involving financial institutions and the investment community.

Tim Zawacki   00:00:13

I'm your host, Tim Zawacki. Today, we're digging into commercial real estate lending, where loan performance stands, which property sectors are attracting capital and which aren't and what's ahead for depositories and others active in CRE lending. And we're doing it against a genuinely unusual macro backdrop, sticky inflation, a Fed that looks closer to hiking than cutting and a treasury market that's been anything but quiet with long-end yields recently hitting multi-decade highs. Joining me today is Michael Fratantoni, Chief Economist and Senior Vice President of Research and Industry Technology at the Mortgage Bankers Association. Mike, welcome to StreetTalk.

Michael Fratantoni   00:01:00

Thanks, Tim. Great to be with you.

Tim Zawacki   00:01:01

So Mike, let's start with the numbers. your organization, MBA just recently issued its second quarter 2026 quarterly survey of commercial multifamily mortgage bankers originations. And some pretty striking numbers, I thought in that report with overall originations up 16% year-on-year and 12% sequentially. After a couple of rough years, is this the confirmation that CRE lending has generally turned a corner? Or is there some more nuance underneath those significant increases?

Michael Fratantoni   00:01:37

Yes, that's a great question. And as you know, with commercial real estate always the aggregate numbers might be interesting, but there is so much variety of experience, let shall we say, across the industry. And it shows up in these numbers, too, right? -- showing some very strong growth, particularly for depositories and CMBS and investor-driven lenders, much less for the GSEs and life insurance companies. And so we can dig into that. But the aggregate number would suggest, as you said, fairly strong pace of origination activity, but I think it really depends where you sit and what types of loans you're working with as to whether that really gives you a good sense of the current market dynamics.

Tim Zawacki   00:02:26

So let's drill into that a little bit. The numbers for the depositories was the one that really sort of jumped off the page. I guess when you think about the CMBS market and some of the conduits, there's ebbs and flows and peaks and valleys and so forth. And in the data, but depositories up 61%. That's a very large number. What are your sense is behind that?

Michael Fratantoni   00:02:49

Yes. When I look at these data, we show it 3 different ways. We show it year-over-year for the quarter and then relative to the prior quarter. And then my favorite is looking at a year-to-date compared to year-to-date in the prior year and for depository showing 69% growth first half '26 compared to first half '25. And the way I really think about that is looking back to the maturity wall, and I know a lot of people are not wanting to talk about that anymore because it's gotten so much attention in recent years. But our estimate was that 2026, there was going to be $875 billion worth of scheduled maturities for commercial mortgage loans this year and about half of those were sitting on depository balance sheets. So I think a lot of banks very much came into this year with a resolve that no more kicking the can down the road, these loans were going to get moved one way or another, ideally with new financing in place, but some are going to take a different path and get worked out, but they really saw -- and this is, again, thinking back to earlier this year in February in our CF conference, this was the year to really redesign the balance sheet a bit and provide financing, grow where you can and then also do that compositional change leaning into the areas of the market where you have more optimism.

Tim Zawacki   00:04:19

Life insurance is an area that I spend a lot of time focusing on, and we've heard a number of different pieces of feedback from the market there that might be influencing some of the statistics you're seeing. And one of the key points that I think we've heard from a number of folks in the market is on the supply side that there just isn't in this sort of higher interest rate environment, the kind of supply of your traditional 10-year fixed rate Class A property loan out there in the CRE realm for the life insurers to originate. What do you suspect is behind the life sector's retreat? And maybe is it really a story of high rates?

Michael Fratantoni   00:05:03

Yes. I think that's a good point. When we talk to our life insurance company members, part of it is the sort of traditional part of the yield curve where life insurance companies prefer to lend is longer term, right? That was a good match for the liabilities they have. And yet we're in a market where more and more of the volume is being done at a 5-year tenure or shorter -- and I think you certainly have a number of life insurers who are more than willing to meet where that market demand is, but it's not really natural habitat for them, again, given the structure of the liability side of their business. On the other hand, if you look at the types of assets that are available, again, I think you would think that in an old school life insurance company portfolio, as you said, much lower credit risk, but a lot of trophy office and a lot of retail, and those are property types that while they're growing again now, just are not seeing the types of volumes that we saw in real estate cycles past. And so if more and more of the overall commercial markets being done in the multifamily sector, I think life insurance companies will do multifamily loans as well, clearly, but there's a lot of competition in that space for a limited number of loans.

Tim Zawacki   00:06:26

One of the property sectors that's been getting an awful lot of attention lately, and I think from people in the market that are doing their due diligence on potential opportunities, but also from a macro standpoint has been in the data center space. Now industrial has been one of the property types that's really been pushing the CRE market forward really going back since the pandemic. And if we include data centers in that, it's been certainly part of that momentum. But what's your read on how much of a role that data center build-outs are playing in driving growth in industrial? And what opportunities may we see or concerns might we see emerge just as this becomes more and more of a political hot potato.

Michael Fratantoni   00:07:15

Yes, great question. So I think the industrial sector was doing quite well even without the data center activity, perhaps a little bit of overbuilding as we were in '24 and '25, and it sure seems like that's being absorbed really across the country in a pretty good fashion even with all the trade and other challenges that might be influencing that. We are in the process and thinking about sort of we regularly are tweaking our surveys, is it time to just break out data center as a completely separate category. And there's a number of reasons for that. One is, as you know, there are more zeros in those loans than you have in other property types. These are just enormous amount of dollars at stake in the bank space, you often see it being large syndicated deals. And then there's also the fact that at least from what we're seeing is so much of the activity right now is on the construction of these properties. And I think there's still a little bit of uncertainty about where they'll actually end up once you get to stabilized facilities that are fully completed. And obviously, some of that will wind up as commercial real estate loans. But I'm just -- I'm thinking a whole lot of it right now is in the construction phase still. And exactly as you said, boy, a lot of media coverage now and it's entering the midterm political cycle of community neighborhood pushback against some of the disammends that come with having a data center in your backyard. And it's pretty striking that this is really again across the country, bipartisan basis, politicians hearing those concerns and pushing back to some extent. So I think that will easy to predict. That's going to slow the build-out. It's certainly not going to stop it. Boy, this thing has so much momentum.

Tim Zawacki   00:09:14

When we look at all the property types in the originations index, and there's 6 categories altogether, for those of you who have not seen these reports, and I would certainly recommend that you go to the Mortgage Bankers website and download them. Multifamily and industrial, the index values there for both of those property types are quite elevated, but then you have the embattled property types, retail and office. And while the index values are still significantly lower, they've recovered quite a bit off of their lows. So what do you see going on in the sort of beaten down asset classes, those property types have the concerns that have loomed over those property types dissipated? Have people gotten more comfortable, generally speaking, lending against office and retail?

Michael Fratantoni   00:10:09

So if we were talking a decade ago, we would be talking about the retail apocalypse, right, and how we were 1,000 malls oversupplied relative to what we needed or something. But for better or worse, we're not building much new retail at all and the conversions and other redevelopment efforts that have happened, I think, have probably got us closer to right size than we've seen in some time. And then there's appetite for lending on retail facilities. We also haven't built much office, thank goodness. I think we're still a bit up in the air about whether we're at the end of the return to office effort or whether we're still in the middle. It sure seems like in some metro markets and you follow all the data about transit use. It looks like in New York, you're getting pretty close to where we were pre-pandemic. I'm talking to you from D.C. today and still not even close to what we were seeing in terms of transit use, and that's a pretty good reflection of how much pain is being felt in the D.C. office market right now. And I think you have all points in between in other markets around the country. You look at the breakdown in some markets, it's Urban office is really struggling, but suburban office is doing okay. Medical office, always a stronghold in many cases. But I think most of the worry was around trophy office towers in major metro areas. And -- but again, even within that, you see pretty striking differences between San Francisco, which is now booming and some other markets around the country, which are feeling their vacancy rates pretty significantly.

Tim Zawacki   00:11:53

It's interesting. We, of course, saw a lot of talk about office to multifamily conversion projects and S&P's global headquarters on Water Street is actually located right across the street from the SOMA conversion project, which has turned what I don't think I would go too far out in the limb here and saying was a pretty ugly office building into a spectacular multifamily residential tower. And of course, I think more recently, we've heard some headlines about a conversion project in Manhattan that had a bit of difficulties with the structure. Is that something that you expect to see continue? Or is multifamily to the point where supply is more in line with demand?

Michael Fratantoni   00:12:37

Yes. I think there will be areas where some of those conversions make sense. It's always been the challenge of maybe 10% of office properties were even a candidate just given their physical structure. And then it gets to your larger question of is the demand there? In a world where we're seeing vacancy rates on multifamily properties continue to go up, you're seeing asking rents at the national level declining on a year-over-year basis by some measures and particularly across the Sunbelt to still abundant supply. And I know folks have pointed to the fact that incremental additional supply coming online is beginning to slow. But we did a white paper a couple of months ago, just trying to highlight the fact that the demand picture has changed quite a bit, too, right? You already knew that the Gen Z cohort was considerably smaller than the millennial cohort. And then put on top of that, the really sharp change in direction of immigration policy -- and I just think that's going to, for at least some time, going to really be a negative headwind for demand for rental housing. And so if we're generating 500,000, 600,000 new households per year, and let's say, half of those are rentals, and we're still building 1.3 million units, I think we're more than adequately supplied in most of the country really for the foreseeable future. And I'm not going to be surprised and it's in our forecast if you see that multifamily starts number begin to come down to reflect that reduction in demand.

Tim Zawacki   00:14:24

Interesting. I would be remiss to not take the opportunity speaking with an economist to delve into some of the, I guess, you could say, complex and rapidly evolving macroeconomic landscape that we're facing in full disclosure, we're recording this on the eve of the Fed's Jackson Hole retreat. So of course, it's very possible that things may change between now and when this episode is available. However, with that being said, the Fed is now fifth straight time in July where they held the target rate steady, but it seems like the momentum towards rate hikes is building. And Mike, I was curious as to where you stand, what your forecast looks like for the balance of the year as it pertains to what the Fed is going to do.

Michael Fratantoni   00:15:16

Yes. Our forecast is that their next move is a hike, but then they're going to wait until early 2027 to do it. Boy, it's going to depend very much on what these next couple of inflation readings show. So we'll get one on the PCE measure, and then we'll get a CPI before their September meeting. But the combination of inflation stuck in the mid-3s, a job market that's holding up reasonably well. Chairman Wars had a 9 to 3 vote at the July meeting. I don't think he's going to lose a vote before January. And I think by the time we get to early next year, I think it will be clear that inflation is going to be too sticky, well above their 2% target without some additional nudging from policy. In terms of longer-term rates, you started things off with, boy, this has been unpleasant the last couple of weeks, seeing the 10-year up to 4.7% and beyond. I just don't see a lot of forces which are going to push it down too much further. So we really have that in our forecast now of 4.6%, 4.7%, 4.8%, somewhere in that neighborhood really for the next couple of years. But I think the risk is that we go higher and that growing concern from investors globally on the fiscal situation, not just in the U.S., but across Europe and Japan, elsewhere, there is just a whole lot of debt being issued and limited appetite to take it all on at current yields.

Tim Zawacki   00:16:49

And when you think about some of the inflationary pressures that are out there, some of them, of course, have been exacerbated by tariff policy, and we've now entered some renewed hostilities with Canada, and that certainly would seem to have the potential to impact building costs when you think about lumber supply from Canada, not just in the commercial real estate realm, but also residential, of course. So what's your view on how tariff policy intersects with inflation and maybe how the Fed should think about that?

Michael Fratantoni   00:17:20

So biggest picture, if we're in a world that trades less globally, that's going to be inflationary generally because everyone is going to be suboptimal in terms of how they're procuring resources of various types. And so on net, that's going to be lower productivity, more inflation than in any world with freeer trade. I'm kind of old school that way. That's the way I was talking in grad school, and I think it's still the right way to think about the world. In terms of sort of our particular sector, I think people have talked about really stagflation and particularly the multifamily sector for some time, right, where expenses are growing and your revenue isn't. -- talked about asking rents negative on a year-over-year basis by at least some metrics, but by any of them, why is not growing very rapidly given the mismatch between revenues and expenses. If you flip that now to the other side, so much of measured inflation is coming from shelter costs, right? So whether that's rent of your primary residents or owners' equivalent rent. And the way those are measured, those have been very sticky over time and have contributed to the overall inflation exceeding the Fed's target. But now that's flipping. The shelter cost numbers are coming down, and that will help pull the inflation numbers back towards the Fed's 2% target over time, absent these other things that are pushing up with the spike in energy prices, the impact of tariffs, et cetera.

Tim Zawacki   00:18:59

Can't forget about energy prices. It seems like there are so many different issues that come up from a macro standpoint that just pop up and have the potential to impact markets. With that, I guess, being said, what worries you for the next 6 to 12 months in terms of impacting the durability of this recovery that your data is showing in the CRE markets?

Michael Fratantoni   00:19:22

So first, the good news, right, is like we do a monthly survey of quoted spreads on different types of loans. Spreads are tight, right? Whether that's because investors see new commercial mortgage loans as really attractive assets or because they really don't like the alternatives like we were just talking about, whether that's treasuries or elsewhere, either way, on a relative value basis, it looks pretty good. But there's a lot to worry about, right? And I mentioned that thus far, the job market is holding up pretty well. But there are some signs of shakiness there, right? The job growth we're getting is increasingly concentrated in just a couple of sectors like health care being the predominant one. And so it's not going to take much for the job market data to start looking worse. And I'm not talking about a recession, but just any sort of slowdown in pace of economic activity will be felt by the commercial market. On the other hand, if inflation stays higher than we're thinking, and we think we're above the Fed's target until 2028, that means higher long-term rates and the $875 billion maturing this year, a lot of those property owners, I'm expecting, we were waiting for rates to drop before they made their move and a lot of folks looking to transact. We're waiting for rates to drop. And if it doesn't happen, I think there are going to be a few folks caught without a chair in the scheme of musical chairs. And so we'll probably see a pickup in delinquencies and workouts and special servicing rates, et cetera, right? Because that will add to stress if there's not a viable exit strategy for some of these folks.

Tim Zawacki   00:21:04

So we have plenty to worry about. I guess, one thing you mentioned earlier, I'm wondering, as we conclude here, the midterms coming up in November. Anything that comes from that we should look towards and impact it might have on CRE? Or should we maybe look forward to a deadlocked Congress for the next 2 years where we just maintain the status quo.

Michael Fratantoni   00:21:29

So believer in the wisdom of crowds, and I think it is just fascinating now seeing all the prediction markets and what they're showing. And they are now looking for a change of control of both houses of Congress. And to your point, that would mean a very divided government, which usually means less gets done either for good or for ill. And so that's likely what you might expect, but boy, you probably remember the last several elections, it seems like midway through election night markets respond to whatever the big news item is. And so I think you can put more confidence in a bet that there's going to be volatility around the election results. Not quite sure which way, but I think just given the challenges in polling these days, given the challenges in understanding who's going to turn out in a midterm election, we're all going to be surprised when those results start coming out that evening. But the commercial market per our numbers, boy, very strong first half of the year. We'll have to see how things proceed as we get through the second half. starting from a position of strength. Michael Fredatoni, Chief Economist, the Mortgage Bankers Association. We appreciate you joining us here on StreetTalk. Thank you very much.

Tim Zawacki   00:22:48

Great to have you.

Tim Zawacki   00:22:48

That's it for this episode of StreetTalk. Thanks for listening, and we'll catch you next time.