Is Dallas at Risk For a Wave of Commercial Real Estate Defaults?

A new study from Commercial Edge shows that more than 52 million square feet of Dallas office space and more than 87 million square feet of Dallas industrial space will have loans reaching maturity between 2023 and 2025. With vacancy rates hovering at 17.2 percent for office and 5.5 percent for industrial, some strategically minded investors are scanning the market for commercial real estate properties with loans coming due in a much higher interest rate environment or those properties that will qualify for fewer proceeds than debt service, thus creating a large capital gap.

How big of an issue could a wave of distressed commercial properties cause? According to the Mortgage Bankers Association, there are $4.5 trillion in commercial mortgages in the nation with more than $1 trillion maturing between now and the end of 2025. According to Commercial Edge, an uptick in distressed properties is a near certainty, but the extent of the problem is less clear.

What Commercial Real Estate Markets Are at Risk?

Dallas ranks third after Chicago and Atlanta with 87.3 million square feet of industrial square feet reaching maturity between now and 2025. Likewise, Dallas came in sixth after Washington, D.C.; Manhattan; Chicago; Los Angeles; and Atlanta with just over 52 million square feet of office space coming due in the same period. However, experts noted that not every market carries the same risk for a wave of commercial real estate defaults.

We asked Paul Fiorilla, director of research at Yardi, about how the Dallas-Fort Worth region is positioned considering the market conditions for industrial and office properties. Here’s what he had to say about the report and North Texas’ resilience in the commercial real estate market:

The criteria we set out is that the amount of distress will be based on asset type, market/submarket, loan seasoning, and strategy of borrowers and lenders. Some of those criteria are market specific and some are an issue everywhere. Using that criterion relative to the rest of the country Dallas-Fort Worth is in good shape. Population and job growth consistently are among the best in the nation so demand in most property segments should remain strong.

That doesn’t mean, however, there won’t be an increase in distress. Dallas might be less affected than other markets, but property values everywhere will decline if interest/mortgage rates remain high. Dallas’s office market is healthy compared to some other large metros, but still office usage is barely above the 49% national average as of May, according to Kastle Systems data, which means occupiers will reduce space demands over time. Dallas’ office vacancy rate is 17.2 and 5.3 million square feet of office space under construction, per CommercialEdge.

According to CommercialEdge, office asking rents in Dallas are down 0.8 percent year-over-year through April, while expenses for things like insurance and tenant improvements are climbing. That means net operating income in many buildings will decline and could create distress.

Other property types with healthier fundamentals have greater buffer when it comes to distress, but individual assets that have disappointing performance or can’t afford a big jump in debt costs will find themselves in need of recapitalization.

I expect that many property owners facing a capital shortfall will work out an extension with lenders, which will keep distress to situations that are extremely far underwater or have no strategic value to the owner.