Before President Trump’s tariff announcement sent markets into a tizzy, the big news in the real estate world was that the surging rate of delinquency on commercial mortgage-backed securities, most notably in the office sector. Indeed, in December 2024, the delinquency rate on office CMBS hit 11%, exceeding even its peak during the height of the 2008 real estate meltdown!
The delinquency rate trended down early this year but is still at an extremely high level of 9.76%. Other sectors of commercial real estate have performed better.
But aside from industrial (with a 0.6% delinquency rate in March 2025), each are still relatively high, with a March 2025 average of 6.65%, and have also been trending upward throughout 2024 and early 2025.
This sounds bad. Indeed, I saw multiple posts on social media talking about this development as if we were on the precipice of another real estate-driven financial collapse—this time driven by commercial real estate.
Now, a recession very well may be imminent (or may even have already started). J.P. Morgan puts the odds of a global recession at 60% right now. But if this happens, it will be driven by a combination of an overvalued stock market, strapped consumers, geopolitical uncertainty, and a trade war, not real estate.
The reason is simple: Commercial real estate is a relatively small percentage of real estate overall. The office sector itself only amounts to about 16% of commercial real estate as of 2018, and commercial real estate is only 19% of all real estate. (Industrial, retail, hospitality, and multifamily make up the other types of commercial real estate, although it is sometimes broken down further with sectors like medical or special-purpose included.)
All residential real estate (including multifamily, which is confusingly classified as commercial) accounts for 81% of all real estate.
Thus, the office sector accounts for substantially less than 10% of the real estate sector as a whole. And single-family housing is the biggest sector by far. (There are about 85.3 million SFR and 32.6 million multifamily units in the United States as of this year.)
Single-family homes were the epicenter of the 2008 mortgage meltdown, but the trends in delinquency for single-family homes haven’t budged at all in the last three years since coming down from a brief COVID-19 pandemic-induced spike. As of February 2025, serious single-family delinquencies are sitting at just 0.61% for Freddie Mac and 0.57% for Fannie Mae.
This graph makes it look as if the economy is in tip-top shape.
That said, this is a bit misleading. Serious delinquencies mean the loans are at least 90 days past due. The CMBS delinquency data is for 30-day delinquencies or more. In order to compare like with like, we have to look at 30-day delinquencies, which Fannie Mae and Freddie Mac did not report.
The Mortgage Bankers Association National Delinquency Survey (NDS) looks at a slightly different cohort than Fannie and Freddie. It includes loans on any property that is one to four units and includes non-Fannie and non-Freddie mortgages. Their most recent survey found a total delinquency rate of 3.98% for such mortgages in Q4 2024, of which 1.19% were at least 90 days past due.
Still, this is barely more than half of CMBS and a third of the office CMBS delinquency rate. And further, residential delinquency rates remained flat for years, whereas commercial is going up and office is surging.
So what’s going on?
Why Have Office and Residential Diverged?
The office sector has had a rough go of it, particularly in downtown areas. Back in 2022, I noted that downtown office real estate was in bad shape. Vacancy rates were at recession, if not depression, levels in many metropolitan areas.
“[D]owntown Los Angeles office space has hit 25% vacancy. In Manhattan, it’s over 17%, downtown Portland, Oregon, is at 26% vacancy, and in Washington D.C., it stands at 20%.”
But things were going to get much worse. The writing was already on the wall:
“The reason we can know for certain that this problem is going to get worse is the way commercial leases are structured. Unlike the typical lease on a home or apartment unit, commercial leases are usually 3-5 years long and sometimes more.
“Downtown commercial real estate was already declining before 2020, but the pandemic turbocharged that decline. Many of the firms that signed leases in 2017, 2018, and 2019 are stuck in those leases for a few more years. But all signs point toward a large number of them leaving after the end of their lease.”
Well, it’s been three years since then, and this has all come to pass, with vacancy rates breaking 20% in mid-2024.
Unfortunately, commercial mortgages are structured similarly to commercial leases. The vast majority of such loans have terms that run between five and 10 years. This does not mean that the borrower needs to pay off the loan after five to 10 years. What it does mean is that the loan’s interest rate will reset to market at that time.
And let’s remember what happened to interest rates in late 2022:
At the same time, commercial property values plateaued in 2023.
Finally, to make matters worse, inflation has been substantially higher in recent years than before, which increases operating costs on everything from utilities to insurance.
Thus, numerous commercial property owners bought or refinanced before 2022, with debt service expectations way below what they would be if such properties were bought today. Now, those purchased or refinanced between 2015 and 2020 are starting to have their mortgages reset to market rates. This is killing their profitability and, in some cases, driving the owners into delinquency.
For single-family houses, the story is completely different. In fact, this was the main reason I was so certain that no 2008-style financial crisis was looming (at least, not one that originated from real estate). As I noted:
“The other factor that made loans unpayable [in 2008, aside from loans made to uncreditworthy borrowers] were the interest rates that shot up after the teaser rate expired… those are mostly gone. But in addition, there are fewer adjustable-rate mortgages than there were in the years before the crash. As The Financial Samurai points out, only 4.7% of mortgages taken out in 2021 were adjustable-rate mortgages! The rest were fixed-rate.
“For comparison, back in 2006, almost 35% were adjustable-rate mortgages.”
After 2008, adjustable loans on single-family homes went the way of the dodo bird.
This has made it more difficult for homeowners to sell, as they are locked in with golden handcuffs and cannot afford to buy the same home now as they could before mid-2022, when rates were substantially lower. Sales volume has fallen since rates went up, but home prices didn’t go down. In fact, they have consistently—albeit slowly—gone up.
Thus, increased rates have added no pressure to homeowners’ ability to pay as long as they don’t move. And unemployment is still low, which takes away the largest cause of people falling behind on their mortgage payments.
But even if a homeowner does get into trouble, since prices have gone up and homeowners are paying off principal each month, they can generally still sell and pull out money above and beyond paying off the mortgage. So, even if they do fall behind, foreclosures are rare.
What Will the Ramifications Be?
Commercial real estate is struggling, and the office sector is doing particularly poorly, but it’s important to keep things in perspective. The actual number of commercial foreclosures, while rising, is still relatively low. In May 2024, country-wide commercial foreclosures hit 647, up 219% year over year, but still almost 30% below where they were in 2014 and way below where it was during the Great Recession.
While commercial properties have seen only a little appreciation in recent years, everything bought before 2022 saw significant appreciation in those years. And no matter what, owners were paying down the principal on their loans the whole time. Thereby, even with significantly higher vacancy rates and a flat market, distressed commercial property owners can usually sell without getting foreclosed on.
The only acute concern regarding offices is in particular submarkets, most notably some of the distressed downtown areas noted. (Although some of those areas, such as New York City’s downtown, are showing positive signs of a comeback.)
I see nothing in the data that shows commercial real estate could collapse and bring down the rest of the real estate market or the economy, as it did in 2008. So that’s good.
That being said, commercial real estate, in general, and office in particular, are quite fragile right now. If a trade war kicks off or the stock market does turn out to be highly overvalued and the air is just now coming out of the balloon, that push could send commercial real estate spiraling as a second-order effect.
Those factors would make me nervous to buy commercial right now, particularly office, but not so hugely concerned to sell what I have.
One Last Note of Advice
If you have a low-interest mortgage about to reset its interest rate to market, a good approach to consider is to request to re-amortize the loan. This would start the loan over from the beginning.
So, for example, if you are five years into a $1 million loan amortized over 25 years at 4.5% interest, the payment would be $5,558.32. If it resets to 7% interest, the mortgage payment would go up to $6,752.07 and would likely make the property untenable.
However, after five years, the mortgage has been paid down to $878,579.03. If you re-amortized the loan and started it over at its new principal amount, the payment would be only $5,932.23. It will still be almost $400 more than it had been but $800 less than it would be otherwise. That spread could be the difference between profitability and delinquency.
This is especially true for loans that have been paid down even further. We have re-amortized several loans that were five to 10 years old. In one extreme case, the interest rate went from 4.25% to 8%—yet our payment actually went down!
Not all banks will do this, of course. In fact, it might only be local banks that will do so without simply refinancing the loan. And yes, we are not paying off anywhere near as much principal each month on the loans we’ve re-amortized, but cash flow is king in real estate. So it’s something to consider as more and more pre-2022, low-interest commercial loans reset in the years to come.
After all, you can pay your mortgage with equity.
