Bloomberg Evening Briefing: ‘First Shoe’ Drops on Obscure Real Estate Instrument

There’s a new red light flashing when it comes to commercial real estate. An obscure investment product used to finance risky projects is facing unprecedented stress as borrowers struggle to repay loans tied to commercial property ventures. Known as commercial real estate collateralized loan obligations (CRE CLO), they bundle debt that would usually be seen as too speculative for conventional mortgage-backed securities. In just the last seven months, the share of troubled assets held by these niche products surged four-fold—rising by one measure to more than 7.4%. For the hardest hits, delinquency rates are in the double digits. That’s left major players in the $80 billion market rushing to rework loans while short sellers ramp up attacks on publicly traded issuers.

The pain of course is part of a broader, post-pandemic shakeout in the $20 trillion US commercial real estate market, which almost brought down New York Community Bancorp and has elicited warnings from Treasury Secretary Janet Yellen and Federal Reserve Chair Jerome Powell. Yet industry observers say few products are more exposed than CRE CLOs. “The CRE CLO market is the first shoe to drop in terms of defaults in the CRE debt markets,” said Mark Neely, director of alternative investments at money manager GenTrust. “The loans inside CRE CLOs tend to be for transitional properties, so the borrowers are counting on reselling them before the loan matures. But today many borrowers can’t sell properties for anywhere near where they bought them.”