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Higher rates are weighing on America’s office market.
Distress is rising for “Class B” properties outside major metro areas.
“Everything is ripe for the losses to be taken, for these assets to be moved at a discount.”
Facing predictions of a coming apocalypse several times already in this decade, America’s office market has mostly bucked the gloomiest expectations.
Amid the pandemic and a wave of debt maturities, investors braced for soaring defaults and a cataclysmic plunge in office valuations. But a disaster of the magnitude that had been predicted never came, and the market held up. It did so again in 2023, even as rates rose in response to inflation and sparked more talk of a debt crisis in commercial real estate .
The math has changed now, though, and not for the better.
This year has seen a surge in bond yields as markets recalibrate expectations for inflation and rates amid the Iran war and a shaky fiscal outlook. Fears are rising once again that higher borrowing costs could destabilize the commercial real estate market — particularly America’s weaker offices , the “Class B” properties outside major metro areas that have struggled as remote work trends persist.
That segment is just one slice of the broader commercial property market, but it’s already seeing a larger share of distress as borrowers come under pressure. It also faces a large wave of maturities , with more debt coming up for refinancing at a time when rates look poised to stay higher for longer.
The result could be a wave of defaults that lead borrowers handing the keys to lenders, and fire sales that lead prices to drop as much as 40%, real estate experts told Business Insider.
Higher borrowing costs have already pushed the US office market to near “peak distress,” Lonnie Hendry, the chief product officer of the CRE market intelligence firm Trepp, said.
The delinquency rate on commercial mortgage-backed securities backed by office loans has hovered near a peak of 12% for about the last ten months, a five-fold increase from the peak delinquency rate of 2.5% in 2021, Trepp data shows.
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Defaults on office CMBS loans also remain elevated after peaking in 2025. The balance of newly defaulted office loans clocked in at $6.8 billion in the first nine months of the year, Trepp data shows, on track to land near last year’s $10.5 billion.
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According to an estimate from MSCI, more than 20% of offices with loans set to mature in the second half of 2026 are underwater, meaning the mortgage is higher than the property’s value.
Trepp’s value-weighted Property Price Index, a gauge of commercial real estate valuations, is down nearly 16% since the third quarter of 2021.
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Commercial mortgages are priced over Treasurys, and distress has risen alongside the spike in yields this year.
The benchmark 10-year US Treasury yield is not far from 5%, even after this week’s decline amid a broad risk-off move in the stock market. The yield has surged 67 basis points since the beginning of the year.
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Rob Koonin, the co-head of Polsinelli’s New York real estate practice, told Business Insider it could take as many as 12 months for the full effect of higher rates to hit office valuations, adding that a 10% decline could be realistic for some Class B buildings.
“It will really hurt already fragile borrowers,” Koonin said. “So if you already were having difficulty, it’s going to push you over the edge.”
Trepp’s Hendry estimated the most troubled buildings are facing a valuation decline of up to 40%, though the impact will depend on the market conditions in each location.
“These are not just headlines; this is actually just where the math doesn’t work, and borrowers are going to have to put in additional equity to try to get their loans refinanced,” he said.
“I think all of the storm clouds are there, all of the ingredients are there, whatever analogy you want to make. Everything is ripe for the losses to be taken, for these assets to be moved at a discount.”
Extend and pretend no more
Higher rates make lenders less willing to modify or extend loans without seeing more cash or equity upfront, Trepp’s Lonnie Hendry said.
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Commercial real estate financing is much more complex than residential. Properties are backed by a mix of debt and equity that’s sliced and diced in a variety of ways. Debt on most properties is so immense that a shift in borrowing costs of just a few basis points can completely change the economics.
When rates rise, a few things could go wrong:
Borrowers with floating-rate loans could see immediate stress as borrowing costs trend higher, Koonin said. Around 45% of office loans originated since 2022 are floating-rate, according to an analysis from Cushman & Wakefield.
Borrowers must refinance at higher rates, Trepp’s Hendry said. That spells trouble for borrowers already facing issues with occupancy, and lenders might want to charge even more to cover the higher risk of default. Borrowers might need to pursue novel financing solutions or put in more equity.
Last year, distressed office sales soared 53%, with more properties being auctioned out of bankruptcy, foreclosure, or lender seizure.
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It used to be that lenders would often do everything they could to extend or modify loans when possible, Hendry said. For some, the idea is to extend for several years with the hopes that financial conditions will be easier down the road, a move in CRE parlance known as ” extend and pretend .”
But lenders are less forgiving today, Hendry said, noting that many have taken a more “rigid stance around the refinance math.” As rates rise, every dollar of net operating income is worth less tomorrow than it is today, meaning the desire to extend has waned, he added.
At that point, the lender will decide whether they’re looking to revamp the property to add value or try to lease the building to maximize revenue before selling it. In some cases, a lender may sell it at a steep discount to get it off their books.
The result is a Catch-22 where lenders seem to be left with two options. First, accept that the loan is no longer working. Second, cut their losses.
“If it doesn’t work today, it’s probably not going to work in 12 or 24 months,” Hendry said. “The lender’s going to have to make the decision of, ‘Do we just take the loss?’ Which nobody has, to this point, really wanted to do.”
Around $22 billion of office CMBS loans are reaching final maturity in 2027, Trepp data shows. MSCI estimates that over $310 billion in US commercial real estate loans are on track to mature in the second half of this year. Around half of that debt was originated in 2021, when borrowing costs were historically low amid the pandemic.
Last year, distressed office sales soared 53%, with the value of properties being auctioned out of bankruptcy, foreclosure, or lender control rising to $5.2 billion, according to MSCI data.
The market is likely to stabilize once troubled office prices correct, Hendry said, speculating that deal activity and occupancy in these buildings would start to rise. Until then, the market will be searching for someone to hold the bag.
“Those losses have to incur, someone has to take the loss,” he said.
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