Commercial Real Estate Looms As A Massive Market Risk

And Why It’s Worse Than The Subprime-Mortgage Crisis

The heads are finally starting to roll in commercial real estate. 

Seattle’s leading commercial real estate mogul, Martin Selig, has defaulted on $240 million in mortgages on seven office towers. The loan collateral includes two of Seattle’s most prominent office towers, a recently redeveloped former Federal Reserve complex and a brand new 15-story tower at 400 Westlake Avenue. These were Class A office properties. Selig is the most prominent commercial real estate developer in Seattle. He once owned a third of all Seattle office space, including Seattle’s tallest building, the 76-story Columbia Center. 

The loans matured in 2019, but Selig was able to avoid default for more than a year. Downtown Seattle office vacancy is currently 35%. That’s substantially worse than during the Global Financial Crisis (21%)! This unprecedented collapse in demand for office space has created a huge gap between what these buildings were appraised at when the loans were made (in 2019), and what these buildings would bring in an auction today. As a result, the sums owed on the mortgages far exceed the market value of the buildings, which make them very difficult to refinance. 

But, so far, there’s been a huge amount of “pretend and extend” going on as bank managers have strong incentives to avoid foreclosing. Extending principal repayment dates, lowering interest rates – even offering a period of forbearance – is usually preferable to writing down a loan. As long as there’s some way to pretend that a loan can be made good, the banks don’t have to reserve against the losses, which immediately hit earnings and reduce bonuses. 

But these perverse incentives have the impact of allowing losses to pile up inside banks, hidden from investors.

Sooner or later, as one loan after another is revealed to be rotten, investors panic (usually all at once) and begin to sell every bank that’s connected to the business. 

That’s exactly what happened in 2008, with subprime mortgages. The subprime mortgages and the subprime underwriters all went bust in 2007. But the damage didn’t hit Wall Street for more than a year as one major investment bank after another simply pretended that its massive subprime losses were only temporary and could be restructured.

With leading investors like Martin Selig going bust, the obvious question investors should be asking is: how bad will the losses be when all of the B-players default too? 

Well, according to S&P Global, more than $2 trillion of commercial real estate mortgages will mature over the next two years ('25 / '26). The average interest rate on maturing loans (underwritten in '20/'21) is only 4.3%. Good luck refinancing at twice that rate today. 

Nobody is talking about this yet, but the size of this pool of distressed capital is much larger than the subprime mortgage market at its peak in 2005 ($625 billion). 

The "extend and pretend" game the big banks played last year will only make these problems much worse in 2025, because nobody will know where the toxic waste is buried. (Here's a hint: Bank of America.) 

And, I don’t think people have figured out yet that the losses in commercial real estate are going to be much worse than the losses in subprime housing. Even a house that was owned by a terrible subprime borrower can still be cleaned up, repainted, and re-sold to a legitimate buyer fairly easily and cheaply. An empty, 50-year-old office building? Not so much. 

Last month, one of Baltimore’s most prominent Class A office towers (201 N. Charles Street, 28-stories, 268,000 square feet) sold at auction for $2.55 million, or $9.51 per foot. It was sold to its leading creditor for $4.1 million in 2022. It sold in 2013 for $19.7 million. That’s an 87% decline in market price over the last decade. 

Another $200 billion of office mortgages remain outstanding and will need to be refinanced before the end of 2026. 

Good investing,

Porter Stansberry
Stevenson, MD

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