The post-pandemic economic recovery, supply chain strain, high interest rates and geopolitical tensions have combined to create an unsettled market in commercial real estate. This has led to the anticipation of a surge in distressed commercial real estate properties. Distressed properties – those in foreclosure, delinquency, or suffering from high vacancy rates – are likely to become a primary area of focus for lenders and mortgage professionals.

While the Fed has recently lowered interest rates, conditions remain volatile. Mortgage professionals must prepare for this wave of distressed properties, especially as a growing number of loans on these properties near maturity. While some sectors of the commercial real estate (“CRE”) market are showing resilience, others remain vulnerable, particularly as inflation and interest rate volatility strain businesses and their tenants.

The Federal Reserve Board lowered the Federal Funds rate by 50 basis points in September 2024, a significant departure from the usual cut of 25 basis points. Many observers believe that this larger reduction was a response to missed opportunities for rate cuts earlier in the year. While rate cuts could benefit commercial real estate, there is growing concern that the Fed has been too slow to respond to economic conditions, leading the market to increased risk for recession.

This article offers commercial mortgage professionals insight into the evolving landscape of distressed property trends in the post-election economy, the sectors most vulnerable to distress, and the financing strategies that may be employed to navigate these challenging waters.

Distressed Properties in 2024:
A Market in Flux

Those hoping for the 2024 election to be the deciding factor in stabilizing the CRE sector will likely be disappointed, as geopolitical tensions and supply chain snarls still apply pressure to a slow and fragile recovering economy. Office, retail, hospitality and industrial properties are all facing varying degrees of distress, creating both challenges and opportunities. Distressed properties now make up a significant part of the market, with approximately 20% of all CRE loans that matured in 2024 classified this way, according to data from the Mortgage Bankers Association (“MBA”). Let us take a closer look at the health of each sector in the following sections.

Office Sector:
The Crisis of Remote Work

Perhaps no sector has experienced more upheaval than the office space market. As remote work and hybrid models solidify into permanent fixtures of the business world, the demand for traditional office space has continued to wane. According to a survey conducted by CBRE, office vacancy rates in major metropolitan areas are at record highs, with cities like New York, San Francisco and Los Angeles seeing vacancies upwards of 25%. The situation is even more dire in secondary markets, where some offices sit empty for extended periods without any prospects of new tenants. Compounding the issue, many office leases are long-term, meaning companies that committed to large office spaces before the pandemic are now locked into lease agreements they no longer need and/or cannot afford.

For mortgage professionals, the challenge is twofold. First, they must be prepared to work with borrowers who are seeking refinancing or restructuring of their loans in light of declining property values. Second, they must be ready to assist investors looking to acquire distressed office properties at a discount. Both scenarios will require a deep understanding of the current market dynamics and a willingness to negotiate flexible financing solutions.

Retail Sector:
Adapting to E-Commerce and Consumer Behavior Shifts

For the retail sector, the current market conditions can be viewed somewhat as a continuation of long-term trends. This sector was already undergoing significant changes before the pandemic, driven largely by the rise of e-commerce. The COVID-19 pandemic only accelerated these trends, with many consumers permanently shifting to online shopping. While foot traffic has returned to brick-and-mortar stores, it has not reached pre-pandemic levels, leaving many retail centers struggling to attract and to retain tenants. Shopping malls, in particular, have been hit hard, with several high-profile closures and bankruptcies making headlines in recent years. According to a 2024 report from Green Street (the preeminent independent research and advisory firm concentrating on commercial real estate intelligence), nearly 40% of U.S. malls are at risk of foreclosure, with vacancy rates continuing to rise as anchor tenants either close their doors or renegotiate their leases.

That being said, not all retail properties are in distress. Grocery-anchored shopping centers, for example, have shown resilience, as consumers continue to prioritize essential goods. Investors have taken notice and competition for well-performing retail centers remains strong. On the West Coast, grocery-anchored retail centers have shown strong resilience, with several significant acquisitions highlighting the sector’s appeal. For example, Retail Opportunity Investments Corporation (“ROIC”) recently acquired Fullerton Crossroads in Fullerton, CA, and Riverstone Marketplace in Vancouver, WA, for a combined total of $96.5 million.

Fullerton Crossroads, anchored by Ralphs, is a 221,636-square-foot shopping center, while Riverstone Marketplace is a 108,323-square-foot center anchored by Quality Food Center. Both properties are nearly fully leased, reflecting ongoing investor confidence in grocery-anchored retail across the West Coast. Additionally, EDENS, a major retail real estate operator, expanded its portfolio with the acquisition of eight West Coast grocery-anchored centers, including properties in major markets like San Diego, Los Angeles, San Francisco and Seattle. These acquisitions, comprising over one million square feet, are part of EDENS’ strategy to establish high-performing retail hubs across dynamic markets.

For mortgage professionals, the key is to identify which retail properties are likely to remain viable in the long term and which are destined for foreclosure or distress.

Understanding the nuances of local market conditions and tenant mix will be crucial in making these determinations. There can be no substitute for on-the-ground data and knowledge. To be successful in this landscape, mortgage professionals should prioritize building relationships with local stakeholders, conducting regular property performance assessments, and staying updated on regional economic indicators.

Hospitality Sector:
Recovery in Progress

While the hospitality sector was arguably the hardest hit during the pandemic, it has also made the strongest recovery, particularly in leisure destinations. According to the American Hotel and Lodging Association (“AHLA”), hotel occupancy rates have rebounded to 70% in many markets, with revenue per available room (“RevPAR”) nearing pre-pandemic levels. This has been fueled by pent-up demand by consumers to leave their four walls to explore after a long pandemic, not to mention the savings they accumulated during those years because of the travel restrictions that were imposed. It remains to be seen whether this demand can be sustained, as there are signs that travelers are already looking for more affordable travel options, like traveling closer to home or choosing regimented budget tours. This may impact some travel destinations, and particularly upper-budget hotels.

In addition, not all hotels have fared equally well with this resurgence in travel. Urban hotels that rely heavily on business travel are still struggling, and many smaller, independent hotels have faced foreclosure due to an inability to meet debt obligations. Starting mid 2023 through late 2024, the hotel sector has faced increased labor unrest, with a series of high-profile strikes disrupting services and driving up operational costs. These labor actions have added unexpected financial pressures to an already challenged industry. This unrest and a tight labor market have led to rising labor costs. One significant strike involved thousands of hotel workers from major chains, like Hyatt, Hilton and Marriott, who walked off the job in cities including San Francisco, Seattle and Honolulu. Coordinated by the union Unite Here, the strike demanded better wages and increased staffing, addressing issues that arose from staffing cuts made during the COVID-19 pandemic. Workers voiced concerns over unsustainable workloads and wages that have not kept pace with the rising cost of living, despite the hotel industry’s recovery and increased revenues. Unite Here’s president pointed out that many hotel employees struggle to afford housing in the cities where they work and face burnout due to ongoing staffing shortages. These labor actions, strategically timed around Labor Day, aimed to bring attention to the disparity between the industry’s financial rebound and the workers’ quality of life. This, combined with other inflationary pressures, has made it more expensive to operate hotels, further squeezing profit margins.

As a result, there are still significant opportunities for investors looking to acquire distressed hospitality assets, as long as they approach the potential investment with eyes wide open. For mortgage professionals, the challenge will lie in structuring financing solutions that account for the continued uncertainty in the sector, while also recognizing the long-term potential for recovery.

Multifamily Sector:
Resilient, Yet Facing Headwinds

The multifamily sector, often viewed as a stabilizing asset class in commercial real estate, has proven its resilience amid economic uncertainties, rising interest rates, and shifting housing demand. As of late 2024, multifamily properties have generally performed well compared to other commercial sectors.

However, this sector now faces significant headwinds, including higher financing costs, affordability concerns, and regional variations in demand. Rent growth, which previously sustained this sector due to high demand for rental housing and a limited supply of affordable single-family homes, may be slowing as market conditions begin to shift. The rate of increase in rent prices has decelerated in several high-cost urban markets as the affordability of monthly rent becomes an increasing concern. According to the National Multifamily Housing Council (“NMHC”), rent increases across the U.S. have moderated significantly since 2022, especially in cities like New York, San Francisco and Los Angeles, where high rents and inflation are straining tenants’ budgets. There has also been an increase in rental stock in some areas, which could lead to a potential oversupply of rental units; this could weigh on rent growth in the coming years.

The Federal Reserve’s interest rate hikes during the pandemic have resulted in higher financing costs, which present a challenge for multifamily investors. Traditional sources of capital have become more expensive, pushing investors to explore alternative financing methods, such as private mortgages, mezzanine debt and preferred equity. Additionally, underwriting standards have tightened, with lenders seeking lower loan-to-value (“LTV”) ratios and higher debt service coverage ratios (“DSCRs”) to mitigate risk. This has led some potential buyers to step back from acquisitions or adjust pricing expectations.

Multifamily investors are also struggling with an increasing number of rent control policies and tenant protections, particularly in markets like California, New York and Oregon. These regulations, while intended to support affordability, can reduce cash flow potential and limit rent growth, affecting the sector’s profitability. Investors are, therefore, scrutinizing local regulatory environments more closely, and shifting their focus to more landlord-friendly markets in the Sunbelt and Southeast.

In addition, insurance rates are skyrocketing for all property owners, and significantly for multifamily property owners in regions prone to natural disasters. In the Southeast, hurricanes and flood risks have driven insurance premiums sharply higher, impacting the operational budgets of multifamily developments. Similarly, in the Western U.S., the frequency of wildfires in states like California and Colorado has led to increased premiums, with some insurance providers withdrawing coverage in certain high-risk areas. These rising costs are straining property cash flows, especially as many insurance policies now require higher deductibles. Multifamily lenders must account for these escalating insurance costs when underwriting deals. To mitigate these pressures, some owners are exploring strategies such as catastrophe bonds or blanket policies or self-insurance if the owners have large cash reserves, while others are turning to secondary or surplus insurance markets. However, these options also come with their own complexities and costs.

Despite these hurdles, demand for multifamily housing remains strong, particularly in high-growth regions with favorable job markets. The migration patterns toward cities like Dallas, Austin, Phoenix and Atlanta are creating opportunities for multifamily investors, as these areas have demonstrated strong rent growth and stable occupancy rates. According to recent data from RealPage, the Sunbelt markets continue to outperform other regions, driven by population growth, a relative lack of rent control policies, and higher rates of home affordability challenges. The workforce housing segment, which serves middle-income renters, has also gained investor interest as affordability challenges persist in the single-family market. Ultimately, the demand for affordable rental housing is expected to remain high as homeownership remains out of reach for many Americans. Investors are increasingly focusing on value-add strategies, such as renovating older properties to improve rent potential, especially as new construction has become more costly due to high material prices and labor shortages.

Industrial Sector:
A Beacon of Strength

In stark contrast to several other CRE sectors, the industrial real estate market has been a shining star throughout the pandemic and post-pandemic economies. Both e-commerce and supply chain disruptions have fueled demand for warehouse and distribution space across the country. According to a 2024 report from Prologis, the world’s largest logistics landlord, industrial vacancy rates remain at historic lows, with many markets experiencing vacancy rates below 3%. Rents for industrial space have also continued to rise, driven by strong demand from e-commerce companies and third-party logistics providers.

Data centers have become a significant focus within the industrial sector due to the exponential growth in cloud computing, e-commerce, artificial intelligence and digital services, which have all driven the need for robust data storage and processing facilities. According to a recent JLL report, North America’ data center inventory has increased by 16.5% annually since 2019. This growth trajectory is expected to continue in the coming years to meet rising global data demands.

This growth for data centers is not without challenges. Data centers require vast amounts of energy for server cooling and maintenance, making energy costs and sustainability a critical consideration, and even leading to some regulatory pushback for their environmental cost. Regions with abundant, cost-effective power supplies and reliable cooling options, such as the Pacific Northwest and parts of Texas, are particularly attractive for data center development. Additionally, developers are seeking more affordable suburban and rural locations where zoning and regulatory requirements are often less stringent. The increasing competition for suitable land, high construction costs and regulatory hurdles pose challenges to developers, but the continued demand for digital infrastructure continues to make data centers a highly profitable component of the industrial sector.

But, rising construction costs and supply chain delays have added to the expense of building new warehouse facilities, and some markets are facing a shortage of available land for development.

For mortgage professionals, the industrial sector represents a significant opportunity, but one should still heed the challenges. Investors are eager to acquire industrial properties, but they will need flexible financing solutions that account for the rising cost of development and the increasing competition for assets, and to know the regulatory environment of any potential investment.

Financing Distressed Properties:
Strategies for Mortgage Professionals

Given the current state of the CRE market, it is clear that distressed properties will continue to play a significant role in the coming years. For mortgage professionals, this presents both a challenge and an opportunity. The key to success will be developing financing strategies that are tailored to the unique needs of distressed property investors. One of the most important considerations will be the loan structure. Traditional financing options may not be suitable for distressed assets, particularly if the property is in poor condition or has significant vacancies. This creates opportunity for private lenders to provide alternative financing solutions, such as hard money loans, bridge loans or second mortgages, which can provide the necessary capital to stabilize the property before seeking refinancing into a more permanent loan structure. Another important consideration is the loan-to-value (LTV) ratio. Given the uncertainty surrounding distressed properties, lenders may be hesitant to offer high LTV ratios. As a result, investors may need to bring more equity to the table or explore creative financing solutions, such as mezzanine financing or preferred equity.

Finally, mortgage professionals should be prepared to work closely with borrowers to develop comprehensive business plans for properties. A detailed plan should include an in-depth analysis of the property’s current condition, the current local market conditions, the expected cost of repairs or renovations, and a realistic timeline for stabilizing the property and returning it to profitability.

Conclusion:

As we look ahead to Year 2025, it is clear that the commercial real estate market will continue to face significant challenges, particularly in the office, retail and hospitality sectors.

However, with these challenges come opportunities for investors and mortgage professionals alike. By staying informed about the latest market trends, developing flexible financing solutions and working closely with borrowers to navigate the complexities of distressed property investment, mortgage professionals can position themselves for success in the coming years.

The keys to navigating the distressed property market through 2024, 2025 and beyond will be adaptability and knowledge. Those who are able to pivot quickly, understand the nuances of different CRE sectors and provide tailored financing solutions will be well-positioned to capitalize on the opportunities that lie ahead.

Odell Murry is founder and president of MAI Financial Services Inc. He can be contacted at OMurry@MAIFunding.com.