Straight From PIMCO: 3 Stages of Distress in Commercial Real Estate

John Murray, PIMCO’s head of commercial real estate for the Americas, explains the stages of distress that are likely to unfold in the sector due to the economic shutdown – and the diverse opportunities that may arise for investors along the way.

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Text on screen: PIMCO

Text on screen: What is PIMCO seeing in the commercial real estate market?

John Murray: The impact of the COVID-19 health crisis has certainly been felt in the commercial real estate or CRE market.

Image of John Murray

Text on screen: John Murray, Portfolio Manager Commercial Real Estate

The public side of CRE felt the immediate pressure, as the broader public market sell-off included REITs, which were down by about 30%, and even some investment grade-rated CMBS tranches were down over 25% at their March lows.

A bar chart titled, Real estate transaction activity came to a standstill: U.S. CRE transaction volume – 2020 versus prior years, shows how CRE volume in the U.S. dropped substantially in April 2020, relative to 2017, 2018 and 2019.

On the private side, transaction volumes plummeted, bringing the market to a standstill.

COVID impacts were felt across all major property types, but hotels and retail were clearly the most severely impacted given the mandated shutdowns.

Text on screen: Stages of Distress

PIMCO sees this unfolding in three stages.

Text on screen: Stages of Distress

Graphic with a rectangular box that reads: Stage 1: Public Market Dislocation. Under the box is a right-facing arrow with the word: Now.

Right now, we’re in stage one, which is characterized by the public market dislocations we’ve experienced.

Capital market pressures have since dissipated to a degree and corrected by about over 20% so far in the second quarter; but the market remains fragile.

The next wave of public dislocations will be deeper in the CMBS credit curve, as ratings downgrades spur potentially a second wave of selling pressures.

Text on screen: Stages of Distress

Graphic with two rectangular boxes. The left box reads: Stage 1: Public Market Dislocation, and under the box is a right-facing arrow with the word, now. The right box reads: Stage 2: Private Market Stress, and under the box is a right-facing arrow that reads: 6-12 months.

Stage 2 will be the capital injection and balance sheet clean-up phase, which we expect to occur over the next 6-12 months.

Here, we expect the more pro-active, cash-strapped borrowers to seek equity cash flow injections, likely in a preferred equity format, to stave off potential foreclosure.

Additionally, loan sales will pick up as leveraged CRE lending platforms look to avoid default-driven capital calls.

Text on screen: Stages of Distress

Graphic with three rectangular boxes. The left box reads: Stage 1: Public Market Dislocation, and under the box is a right-facing arrow with the word, now. The middle box reads: Stage 2: Private Market Stress, and under the box is a right-facing arrow that reads: 6-12 months. The right box reads: Stage 3: Deep Distress, and under the box is a right-facing arrow that reads: 2-3 years.

Finally, starting in about a year and continuing over the next few years, we’ll enter stage 3, which is the deeper distress that builds slowly through tenant defaults and downsizing.  

Here, even the office sector will not be immune, as the balance sheet pressures from pre-COVID corporate excess, combined with the secular remote working trends that just got supercharged during COVID, could result in a slow unwind in demand that will lead to landlord pressures.

These pressures will collide with a pickup in loan maturities from pre-COVID 2-3 year transitional floating rate loans, which were common in the office space, as well as legacy retail CMBS loans.

Thus, we could expect and should expect a second wave of loan defaults in non-performing loan sales. While the stages of distress are the same as past cycles, the sources and sectors of distress are markedly different.

Split image: On the left is a blue chevron with the text: GFC source of distress: lending excesses in the residential sector. On the right side is a photo of a residential for sale sign with the word “sold” on a front lawn.

If we look at the global financial crisis, the distress centered around excesses in the residential space, including residential development and it was banks, who were active lenders in this space, that were at the relative “center” of distress in the form of non-performing loans

This time, the residential sector’s relatively balanced due in part to improved regulation on banks.

Split image: On the left is a blue chevron with the text: Source of distress now: lending excesses in the corporate sector. On the right is a photo of buildings underneath a cloudy sky.

Instead, the distress this time will emanate from lending excesses in the corporate sector. 

We’re already seeing the early overlap between corporate debt securities and commercial real estate as a wave of major retailer bankruptcies have already kicked off a wave of lease defaults.

Text on screen: So what does this mean for investors?

So what does this mean for investors? PIMCO sees an evolving and diverse array of opportunities emerging in the sector that in many situations will require a deeper connectivity to corporate credit.

Text on screen: Focus areas during each stage. Stage 1:  Dislocated CMBS and private loans, Large corporates; Stage 2: Preferred equity recapitalizations, Sale leasebacks, Secured loans

In Stage 1, our focus has been primarily on CMBS and private loans that are dislocated in pricing primarily due to the broader capital market liquidity driven selling pressures. We’re also seeing a variety of large corporates looking to raise capital by pledging owned property.

In Stage 2, the opportunity set will broaden and include opportunities like preferred equity recaps. But this stage will also include opportunities in the corporate space. Commercial real estate related examples include sale leasebacks and secured loans to corporate borrowers.

Similarly, on top of discounted loan purchase opportunities emanating from over leveraged lending platforms, we expect to see new loan originations opportunities as transaction activity picks up with far less transitional lending platforms in existence.

Text on screen: Focus areas during each stage. Stage 1:  Dislocated CMBS and private loans, Large corporates; Stage 2: Preferred equity recapitalizations, Sale leasebacks, Secured loans; Stage 3: Distressed asset and loan acquisitions

Finally, as we enter Stage 3 in years 2 & 3, we expect to see distressed asset and loan acquisition opportunities emerge as tenant downsizings and defaults collide with loan maturities.

Now while complicated, these can become attractive opportunities for platforms with the expertise in CMBS structures as well as the real estate side in terms of expertise on asset re-positionings.

The main takeaway is that while public markets have corrected to a degree, the pain is far from over and it will play out over multiple stages in many different forms.

Shots of PIMCO’s Trade Floor

PIMCO is prepared to help our clients navigate this environment, not only today, but over the coming months and years as the full cycle unfolds.

Text on screen: For more insights and information, visit

Text on screen: PIMCO


All investments contain risk and may lose value.  Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. REITs are subject to risk, such as poor performance by the manager, adverse changes to tax laws or failure to qualify for tax-free pass-through of income. Private credit involves an investment in non-publically traded securities which are subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss. Investments in Private Credit may also be subject to real estate-related risks, which include new regulatory or legislative developments, the attractiveness and location of properties, the financial condition of tenants, potential liability under environmental and other laws, as well as natural disasters and other factors beyond a manager’s control. U.S. agency mortgage-backed securities issued by Ginnie Mae (GNMA) are backed by the full faith and credit of the United States government. Securities issued by Freddie Mac (FHLMC) and Fannie Mae (FNMA) provide an agency guarantee of timely repayment of principal and interest but are not backed by the full faith and credit of the U.S. government.

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