7 Cities With the Most Distressed Commercial Mortgage-Backed Securities CMBS Loans

In this article, you'll learn:

• Where distress of commercial properties is concentrated
• Why commercial mortgage-backed security loans are troubled
• The impact of CMBS loan distress on commercial properties and tenants

From soaring vacancy rates to rising interest payments and increasing operational costs, the complexities of commercial real estate loans are reshaping the future of office buildings, commercial banks, and the CMBS loan market.

And as cities across the U.S. grapple with varying degrees of CMBS loan concentration, the impact on commercial properties is profound and far-reaching. Because without sufficient net operating income, property owners and commercial borrowers are largely defaulting and walking away.

In the past year alone, the volume of distressed office CMBS loans has nearly doubled, skyrocketing from $26.6 billion in March 2023 to $52.2 billion in March 2024. And some areas have been hit harder as these commercial mortgages come due.

For corporate tenants and directors of real estate, understanding which cities have the highest concentrations of CMBS loans and distress is essential for making informed decisions about leasing, investment, and long-term strategic planning in this increasingly complex and volatile market.

So read on to learn which cities have the highest percentage of commercial mortgage-backed distress and how it may affect your commercial properties.

It's critical to remember that this new environment is symptomatic of an all-out Office Apocalypse. Understanding how distress is geographically concentrated is only one piece to the puzzle. So learn how corporate tenants can survive doomsday conditions and optimize their portfolios in Surviving the Office Apocalypse. Download your complimentary copy below. 

Commercial Real Estate Loans in Troubled Waters

The challenges facing the CMBS market are not just financial but also operational.

Property owners must navigate a rapidly changing landscape marked by shifting tenant demands, evolving work patterns, and heightened economic uncertainty.

Adding to these pressures is the “extend and pretend” phenomenon, where up until now, distressed loans have been modified rather than resolved. However, there are only so many times loans can be extended before reaching a critical threshold.

This strategy of deferring resolution reflects a broader struggle within the CMBS market to manage distressed assets effectively.

As many cities reach a threshold of recession-level distress, the impact on their commercial real estate sectors becomes increasingly severe. The following cities illustrate the extent of the CMBS loan distress, revealing how deeply these markets are affected.

1. Chicago

With a staggering 75% of its CMBS loans distressed, Chicago tops the list.

This distress rate means that 75% of the city's CMBS balance, collateralized by office debt, is either in special servicing or at risk of default.

Factors contributing to Chicago's high distress rate include large loans on specific office properties, such as Willis Tower and 333 South Wabash, which have struggled with declining cash flow and rising expenses.

The financial strain on properties like the Willis Tower in Chicago is further exacerbated by significant increases in real estate taxes. Recently, the building experienced a sharp rise in its real estate tax burden, with taxes jumping from $7 million to $11 million annually.

Unfortunately, many of the distressed properties in Chicago are large, capital-intensive office buildings that require significant investments to maintain and upgrade. With rising operating expenses and the need for substantial capital to improve or reposition these properties, many owners are unable to generate sufficient cash flow to meet their financial obligations, particularly when faced with a weak leasing environment.

Now that 23.0% of office loans are set to mature in the next year, things may get worse. On top of this, excess supply from over-construction is set to further exaggerate the low demand for space and rampant vacancies.

2. Denver

Denver follows closely behind with a distress rate of 65%.

The city's office market has been impacted by similar challenges, including high vacancy rates and rising operating costs, leading to significant distress among its CMBS loans.

Prior to and during the pandemic, Denver experienced a construction boom, adding a substantial amount of new office space to the market. This rapid increase in supply has outpaced demand, contributing to the city's high vacancy rates. With businesses continuing to downsize or adopt hybrid and remote work models, there has been a significant reduction in the need for traditional office space.

As a result, many companies with long-term leases are attempting to sublease their excess space, leading to a surge in sublease availability. This influx of sublease space has further exacerbated the oversupply issue, driving vacancy rates higher and putting additional pressure on property owners and CMBS loans.

And the commercial real estate market is in a complete recession, with the central business district's office vacancy rate plateauing at 31%!

3. Houston

Houston's office CMBS loans have a distress rate of 57%. The city's energy-dependent economy and shifts in office space demand have contributed to its relatively high level of distressed loans.

Like the other markets, Houston’s commercial real estate is also dealing with high vacancy rates and an oversupply of office space. So, the CMBS is sitting on a house of cards supported by a 25% vacancy rate.

Property owners facing financial strain from reduced occupancy and lower rental income are struggling to meet their debt obligations, leading to an increase in distressed loans. Additionally, most CMBS loans in general are structured as nonrecourse, meaning lenders cannot pursue borrowers’ other assets in the event of a default.

This nonrecourse structure, coupled with challenging market conditions, has resulted in a high rate of distress among Houston’s CMBS loans, with many property owners choosing to default rather than continue to sustain losses.

4. Philadelphia

With a distress rate of 52%, Philadelphia is another city where CMBS loans are facing significant challenges. The city's office market has struggled to adapt to the post-pandemic shift toward hybrid work, impacting occupancy rates and revenue.

With fewer businesses leasing office space, property owners are experiencing lower occupancy rates and, consequently, reduced rental income, which is a critical factor in the distress of CMBS loans.

In addition, Philadelphia’s commercial real estate market includes a substantial amount of older office stock that struggles to meet the evolving needs of modern businesses.

5. Atlanta

Atlanta rounds out the top five with a 49% distress rate for its office CMBS loans. Like other cities on this list, Atlanta has faced rising operational costs and changing office space requirements, leading to a higher concentration of distressed loans.

One of the critical factors contributing to the distress in Atlanta's CMBS market is the large number of office loans set to mature soon. By the end of 2025, 29.1% of office loans in Atlanta are expected to reach their maturity dates.

With a high vacancy rate and rising costs, many property owners may face difficulties refinancing these loans under favorable terms. The current market conditions, including higher interest rates and tighter lending standards, are likely to exacerbate this "refinancing gap," where the current market value of properties is lower than the outstanding loan balances.

This gap could force property owners to inject significant capital or face potential defaults, increasing the level of distressed loans in the market.

6. Los Angeles
While not as heavily impacted as the cities listed above, New York and Los Angeles also have notable distress rates for their office CMBS loans, at 25% and 30%, respectively. These figures highlight the widespread nature of the challenges facing the office sector across the United States.

Los Angeles, with a distress rate of 30% for its office CMBS loans, is also feeling the pressure. Rising debt costs have significantly impacted property owners, as highlighted by Brookfield’s default on over $1 billion in loans tied to its downtown properties. The combination of high vacancy rates, increasing borrowing costs, and stagnant revenues has made it difficult for owners to meet financial obligations, adding to the overall distress in the market.

7. New York City

Despite its status as a global business hub, New York City faces significant challenges in its office market, with a distress rate of 25% for CMBS loans. The city's office vacancy rate has lingered around 20%, resulting in approximately 94.0 million square feet of vacant space by the end of Q1 2024. This high vacancy is primarily due to the shift toward remote and hybrid work, which has decreased demand for traditional office spaces, impacting rental income and contributing to loan distress.

Takeaways for Tenants in Commercial Properties

The current landscape of CMBS financing presents significant challenges for both property owners and tenants. With the rise in distressed CMBS loans, particularly in major cities, it’s crucial for tenants to understand the potential impact on their leasing situation.

Commercial mortgage loans, often nonrecourse, mean that if a commercial borrower defaults, the financial institutions holding these loans can only reclaim the property but cannot pursue the borrower’s other assets. This can place tenants in a precarious position, as they might face disruptions or uncertainties if their landlord's financial situation deteriorates.

For tenants, staying informed about the financial health of their landlords and the underlying CMBS loans is essential. In cases where a commercial mortgage-backed loan is distressed, tenants may find themselves caught in the crossfire of financial negotiations and potential property ownership changes. Being aware of these dynamics can help tenants navigate their leases more strategically and mitigate risks associated with potential landlord defaults.

Ultimately, understanding these factors can empower tenants to make more informed decisions and better manage their commercial property leases amidst an evolving financial landscape.