Federal banking regulators acted this past summer to help commercial property borrowers who are struggling with high vacancies, low demand and rising costs.

But the aid, in the form of a new policy statement emphasizing leniency for lenders, hasn't provided much relief, according to industry professionals who are projecting another tough year in 2024 with billions of dollars in loans coming due.

Loan payoffs on office buildings have fallen to historic lows, according to CoStar data. There are fewer buyers for offices than at any time in the past 18 years. And loan payment delinquencies and defaults are rising rapidly.

Lenders are sympathetic to property owners’ troubles in general for any property type because they want to get paid back and are willing to work out a solution. However, it is hard for lenders to offer even short-term extensions on some maturing loans because the higher cost doesn’t pencil out on their bottom lines.

“Before the beginning of COVID, you were getting these fixed-rate loans that were in the low 2% range and if you take that out today, you're in the 7%, or 8% even, and you have a borrower who maybe barely met their debt service coverage ratios or leasing covenants in the twos and now they're scraping by,” Michael Thom, a real estate attorney with the law firm Obermayer, told CoStar News in an interview. “You work with them to try to figure it out. But it's tough. If the value of their building went down and the loan-to-value is supposed to be 70% and now it's 80%, it's going the wrong way.”

Banking regulators, including the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp., urged financial institutions in July to work out loan accommodations with creditworthy borrowers experiencing financial difficulties. The new policy, which had not been updated since the Great Recession more than a decade ago, included offering short-term extensions and the option to defer payments or make a partial payment.

The statement on commercial real estate was more guidance than a rule. Regulators were letting banks know that if those financial institutions do make accommodations or workouts, the officials would not review modifications negatively.

The policy “was issued in part to formally recognize that short-term accommodations are a tool that is available to banks to work with borrowers, and that the FDIC is supportive of such arrangements when done prudently,” LaJuan Williams-Young of the FDIC’s office of communications, told CoStar News in an email. “The decision to make such accommodations on office loans or any other loan rests with [the] bank and not with the Federal regulators.”

The Comptroller of the Currency views short-term loan accommodation as a way for financial institutions to mitigate adverse effects on borrowers, a spokesperson for the agency said.

"We continue to encourage them to work prudently with borrowers who are, or may be, unable to meet their contractual payment obligations during periods of financial stress," the spokesperson said in an email.

Whether the issued statement had much effect is unknown, according to the FDIC and OCC. There is no aggregate data compiled nor any recently conducted studies specific to short-term accommodations, and bank reports do not specifically track such data, according to the regulatory agencies.

Banking regulators continue to pay close attention to banks' commercial real estate loan portfolios but have not indicated that any further guidance to loan accommodations is forthcoming.

“Lenders realize how hard it is for some of these people to refinance right now and they're willing to work with the borrower,” Thom said. “They don't want the borrower to default any more than the borrowers want to default. I think you're seeing short-term extensions, whether it's a year or six months, just trying to help the borrower get to a position where they can refinance.”

Borrowers, though, say they are not getting much of a break. Drew Cunningham, chief operating officer at the Dilweg Cos., said the North Carolina-based real estate investment firm has been collaborating with tenants to work out more flexible leases and would like similar consideration from their lenders.

“We don’t expect lenders to give us a mile, but even an inch would relieve some pressure as we all come to terms with how the market has evolved in the last three years,” Cunningham said in an email. “Office is one of the most capital-intensive sectors in commercial real estate. Equity can’t bear the burden alone and we need our lending partners to move more toward the middle. Office owners would benefit greatly from lenders reopening the capital tap and allowing it to flow for good-news events like leasing, otherwise owners won’t be able to lease, which could cause disruption across the broader market.”

The office sector faces challenges resulting from a sluggish post-pandemic return to downtown workplaces and corporate cost-cutting. That weakness is showing up in loans tied to office buildings that have been packaged and sold to investors on the commercial mortgage-backed securities market.

Since the beginning of this year, the office loan delinquency rate has surged by more than 3 percentage points. The sector's special servicing rate, a sign of troubled debt, has jumped more than 4 percentage points.

The sector stands out when it comes to borrowers needing leniency to pay back loans.

Even more telling is that the payoff rate for maturing office loans has fallen to about one in three for the year and just one in four in June and July, according to data provided to CoStar News by Steven Jellinek, head of research for bond rating firm DBRS Morningstar.

The situation has worsened this fall. In September, the office loan payoff rate sank to 11% before improving in October to 29%, according to the latest DBRS numbers.

“Based on our analysis, the office maturity payoff rate through 2024 could remain in the 25% range because many markets are seeing office tenants come in at rents roughly 30% below pre-coronavirus disease pandemic levels, vacancy rates are at multidecade highs, and most investors and forecasters expect valuations to fall further as the market continues adjusting to higher interest rates,” Jellinek said. “Along with falling valuations, the sector has experienced rising leasing and renovation costs because of rising inflation.”

The issue is compounded by the volume of CMBS office loans maturing in the next 16 months. Among the property types backing CMBS loans that mature through 2024, office is the second most common with some $11.5 billion out of $43.2 billion total in loans, behind retail with about $15 billion, according to DBRS.

CMBS loans get paid off at maturity when the borrower refinances through banks and other lending channels. The debt can be paid in full without refinancing, but that's rare. The declining payoff rate is an indication that fewer lenders are taking on office loan risks or see little prospect of the market improving in the short term, according to CMBS analysts.

Loans can also be paid off through property sales. There is less of that happening as well in the office sector. The $46.2 billion in office building sales in the first half of this year is the lowest half-year total since 2005, according to CoStar data.

While office loan payoffs are at an all-time low, that rate has increased this year for hotel, retail and industrial properties. More than seven of every 10 multifamily loans are still getting paid off this year, according to DBRS data. All hotel and industrial loans maturing in October were paid off, according to the latest DBRS data.

“Most of what's coming to special servicing right now is a maturity issue, especially in the office building market,” Alex Killick, managing director at loan servicing firm CWCapital, told CoStar News in an interview. “With any loan that's maturing right now, or within the next 12 months or so, we certainly view as a maturity risk. But the actual maturity defaults are really just occurring in office.”

Before the financing situation can improve for office borrowers, the market is going to have to settle on office property values, Killick added.

“The fact that a lot of money is sitting out there makes this a weird environment,” he said. “You keep hoping for there to be more price discovery and more of a market clearing for some of these office deals. No one wants to be the one to jump in and buy. Everyone wants to get that big discount and that sort of 2011, 2012 bottom price happening.”

In Killick’s mind, that type of price discovery right now looks like it is about 18 months out, he said.