Bonds backed by commercial mortgages are a ‘disaster’ as real estate values crumble, hedge funder says

The CMBS market is in trouble, United Capital CEO John Devaney says.

The commercial mortgage bond market looks like it’s in shambles, according to hedge funder John Devaney.

Devaney, whose fund was pummeled during the 2008 subprime mortgage crisis, said he saw more trouble ahead for commercial mortgage-backed securities, which are bonds backed by loans on commercial properties like offices, malls, and hotels.

The issues largely stem from high interest rates, which have stoked refinancing fears amid lower property valuations since the pandemic, Devaney said in an interview with CNBC on Friday.

“The CMBS market is actually a disaster right now. Many things are unfolding right now and the bond pricing is telling us things are very, very bad,” the United Capital CEO said, noting steep price declines in BBB- and A-rated commercial mortgage-backed bonds.

Devaney said the office sector looks particularly troubled. He pointed to work-from-home trends from the pandemic, which have started a “slow-moving train wreck” in commercial real estate across the country.

That could spell trouble for cities with large downtown areas, which depend on tax revenue for office spaces, other experts have warned.

“There are dozens and dozens of office buildings that are defaulting now in Chicago, Denver, Los Angeles, San Francisco, Philadelphia is in absolute, such trouble,” Devaney said. “The cities I just mentioned are in such trouble, that most, like half of all the collateral, is worth quite a bit less than the mortgage values right now. There might need to be a bailout by the government or something to help out some of these cities, but there’s real trouble. It’s going to wipe out lots and lots of these bonds.”

Experts have turned a cautious eye toward the commercial real estate space over the past year as Americans continue to forgo commuting to work. Office vacancies notched a fresh all-time-high this year, and office values have dropped 35% from their peak, Fitch Ratings said in March report.

The delinquency rate on commercial real estate loans rose to 1.42% the last quarter, the highest rate recorded in nearly a decade, according to Federal Reserve data.

Some forecasters see more downside on the way for the sector. Commercial property prices could drop another 20% as high interest rates spur a wave of distress, Capital Economics predicted in January.