A Q&A With KBRA About its 2025 CMBS Outlook: Twin Peaks?
(Downtown Chicago. Photo credit: Pedro Lastra)
Kroll Bond Rating Agency, New York, just released its CMBS 2025 Sector Outlook, which forecasts U.S. issuance activity for the new year and highlights key credit trends from 2024. MBA NewsLink interviewed KBRA’s Larry Kay and Aryansh Agrawal to get their views on the current lending environment and property fundamentals as well as factors that may affect overall property performance in 2025.
The report also reviews year-to-date 2024 KBRA-rated CMBS conduit trends and metrics, takes a closer look at this year’s ratings activity, and provides surveillance expectations for 2025.
Aryansh Agrawal is a Senior Analyst in the CMBS Surveillance Group at Kroll Bond Rating Agency. His primary focus is commercial real estate securitization research.
Larry Kay is a Senior Director in the CMBS Surveillance Group at Kroll Bond Rating Agency. He focuses on commercial real estate securitization research. Prior to joining KBRA, he was a Director at Standard & Poor’s (now S&P Global Ratings), where he was involved in CMBS research, surveillance and analytics.
MBA NewsLink: Why do you believe 2025 could be a record year for CMBS issuance given the continuing credit challenges for outstanding CMBS?
Larry Kay: In our view, the commercial real estate securitization issuance momentum that began in 2024 will carry over into the new year as borrowers need to refinance maturities and are accepting current rates. In addition, property valuations are exhibiting signs of stabilization which should help to support transaction activity. While we expect strong issuance growth in 2025, there will continue to be credit challenges on outstanding CMBS. The delinquency and special servicing rates (in default or at risk of default) are expected to continue on their upward trajectory. However, CMBS is a viable source for borrowers looking to finance CRE loan collateral and we believe there will be continued demand for securitizations from investors even in the face of rising default rates.
We also anticipate larger average deal sizes as an increasing number of loans will be originated with continued demand for CRE securitizations. For 2025, we forecast CMBS and CRE CLOs to hit approximately $138 billion, about 20% higher than our full year 2024 estimate. The market will benefit from lower rates owing to this year’s rate cuts, and the potential for further rate reductions, as well as improving property fundamentals and stabilizing valuations. These factors, along with the potential economic benefits of reduced regulation with the incoming administration, will lay the groundwork for increased private label activity.
MBA NewsLink: Could you provide your 2024 issuance recap by transaction type, as well as what we might see for these in 2025?
Larry Kay: Conduit issuance in 2024 benefited from five-year deals, which first emerged in 2023 to offer a product for borrowers that preferred not to lock in 10-year loans at higher interest rates. In 2023, 15 (58%) of the 26 conduit deals issued were 10-year securitizations and 11 (42%) were five-year deals. In 2024, this trend saw a reversal with 21 (68%) of the 31 deals issued through October five-year transactions. For 2025, we believe conduits will continue to be dominated by five-year deals, although 10-year will make a comeback if long-term benchmark rates stay stable or decline. Our forecast calls for a 17% increase in conduit issuance in 2025 from our 2024 full year estimate.
In 2024, single-borrower execution was available for loans that may have been too large for other lenders, such as banks, to finance. Of the 93 SB deals YTD as of October, 15 were in excess of $1 billion. An October deal that exemplifies this size was the refinancing of Rockefeller Center ($3.5 billion of debt), an iconic Midtown Manhattan mixed-use property. SB issuance included all major property types, of which the largest were industrial (27%), lodging (26.3%), and multifamily (16.3%). For 2025, our view is that SB will continue to have a mix of fixed-rate and floating-rate deals and could see volume increase by about 12% from 2024 levels.
Concerns about transitional multifamily loans dampened CRE CLO transaction volume in 2024. Transitional multifamily generally represents all or most of CRE CLO collateral which was challenged with slowing rent growth, increased operating and renovation costs owing to inflation, and record levels of new deliveries. Agency lending (historically the presumed refinance strategy for most of these loans) became tighter with significantly lower leverage and greater due diligence requirements. In 2025, floating rate CRE CLO loans should benefit from prior interest rate reductions as well as multifamily rental rates. We are forecasting that compared to 2024, CRE CLO issuance should increase by approximately 45% from somewhat depressed levels (2024 estimate about 40% of 2022 issuance).
MBA NewsLink: KBRA had a record number of downgrades YTD 2024, do you expect the elevated levels of downgrades to continue in 2025?
Aryansh Agrawal: Year-to-date, October rating downgrade activity ran at its highest pace since KBRA started rating CMBS in 2011. To date, 569 downgrades were effectuated, nearly 200 more than the prior peak in 2021. A majority of the downgrades came from deals that already experienced negative rating actions prior to 2024, and 60.4% occurred on ratings that were non-investment grade at the beginning of the year.
The number of downgrades this year is not surprising given the continued increase in the CMBS distress rate, which includes both delinquent loans and loans that are current but with the special servicer. In addition, the decline in property values through most of the year has increased KBRA-estimated losses on these distressed assets. The total distress rate jumped from 4.6% at the end of 2022 to 8.6% as of October 2024, driven in large part by the office sector, which increased from 3.2% to 13.0% for the same period. Office accounts for the highest property type concentration across the KBRA-rated universe at over 30% of principal balance.
Given the volume of loans maturing in 2025, particularly in the office sector (approximately 32% of total 2025 maturities in KBRA-rated transactions)—and factoring in rates that could remain elevated over the near term, we expect to see a continued growth in the volume of distress, which will likely lead to an ongoing elevated amount of negative rating activity relative to positive actions. We also expect a majority of the downgrades will continue to occur on non-investment grade ratings.
MBA NewsLink: Although large single borrower deals drove much of the volume for 2024, conduit has been the bread and butter of CMBS, what were some of the credit metrics and collateral characteristics for conduits in 2024?
Aryansh Agrawal: Despite conduit issuance almost doubling from 2023 levels, loan credit metrics including both KBRA loan-to-value and KBRA debt service coverage are relatively in line with last year, perhaps with the exception of IO exposure and concentration. The tightening in both credit metrics post-2022 has been influenced by the market’s reducing risk appetite. Pools were less concentrated compared to last year, with loan count and loan Herfindahl Index (HERF) metrics increasing but still falling short of previous years.
KLTV was steady at 88.4% for YTD 2024 compared to 87.4% in 2023 whereas KDSC was at 1.61x for YTD 2024 compared to 1.59x in 2023. The KBRA IO Index YTD 2024 moved higher again, reaching a new peak at 90.4% compared to 86.7% last year, due to an increase in full-term IO loans. Five-year deals contributed to the higher IO index, as their average full-term IO exposure was 92.9%, well ahead of the average for 10-year deals (80.5%).
Office exposure decreased substantially to 19.4% YTD 2024 from 26.8% in 2023, reflecting continued sector concerns. Industrial, lodging, and retail also showed percentage declines but were less meaningful compared to office while multifamily had a 141.5% increase to 22.7% from 9.4%. This could reflect some of the additional due diligence and underwriting measures introduced by Freddie Mac, which may have led more multifamily borrowers to go the conduit route.
We are expecting conduit credit metrics to worsen as lending competition increases. Full-term interest-only loans, which have become the new normal for conduit loans, we believe are here to stay despite a rise in initial leverage.
MBA NewsLink: The report mentions that while office continues to struggle it could be bottoming out. Could you elaborate on that and also provide other property type observations?
Larry Kay: Office, we believe is starting to bottom out as the pace of rent, occupancy, and value declines is slowing, and shrinking construction will start to turn absorption to positive in some markets. However, we have observed that newer assets outperform older ones and there are some submarkets and assets that seem to have stabilized and are poised for modest growth, while others may be stuck at the bottom.
Industrial remains resilient as it continues to benefit from structural drivers such as e-commerce growth and onshoring of manufacturing. With high completion levels in 2022 and 2023, construction activity contracted sharply in 2024 primarily as a result of high interest rates and financing challenges and an oversupply of large warehouse and distribution facilities in certain markets. The overall outlook for the sector remains positive as speculative deliveries decrease which will give the market time to absorb existing supply.
Multifamily fundamentals are expected to improve modestly in 2025 after experiencing some softness in 2024 due to supply that has come online in recent years nationwide, particularly in the Sun Belt states. However, continued demand due to home ownership affordability issues has helped support rents. In addition, demand from millennials and Gen Z continue to prioritize renting, which offers better flexibility, more amenity choices, and better locations than traditional homeownership. KBRA believes multifamily will continue to remain a favored asset class as investors focus on properties with strong existing cash flows or the potential for operational inefficiencies.
For retail, the combination of falling inflation combined with a strong labor market has kept consumers spending, helping to support retail property fundamentals, including vacancy levels and rental performance. Retail continues to perform well in 2024, with landlords having greater pricing power and holding firm on negotiations, due to a combination of demand rising and supply being at record lows. The tenants seeing the most growth in the retail sector have been discounters, experiential spaces, and restaurants. Quick Service Restaurants have seen rapid growth in recent years, however, we believe the surge in chains and restaurants will become overcrowded and lead to a slowing growth rate in years to come.
The lodging industry saw moderate RevPAR improvement as high inflation limited household income, and a strong U.S. dollar pushed some leisure travel abroad. Further stress on the consumer, as well as an uncertain economic environment, could flatten the growth or even turn negative, especially for hotels serving leisure travelers. Over the past year, RevPAR has been driven by commercial and group demand fueled by the need for in-person meetings and corporate gatherings. We expect the lodging industry to continue with only modest growth into 2025.
(Views expressed in this article do not necessarily reflect policies of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes submissions from member firms. Inquiries can be sent to Editor Michael Tucker or Editorial Manager Anneliese Mahoney.)
