More than a third of the $1.4T of commercial real estate loans maturing in the next two and a half years are "potentially troubled," according to a new capital markets report from Newmark.

Some $626B in commercial real estate loans are backed by properties that have debt of at least 80% of the marked-to-market value, according to the report, an indication that the borrowers could have trouble paying off their loans. Nearly half of that debt, or $303B, is held by banks.

Debt funds hold $144B of the potentially troubled loans, per Newmark, an "outsized share" based on their market share.

“Many loans are underwater or nearly so, especially recent loan vintages of most property sector and broad swaths of office debt,” Newmark researchers wrote in the report. “The bigger issue is that the small and regional bank lending engine that has driven the CRE market is rapidly slowing with no clear replacement.”

The report was written by David Bitner, Newmark's executive managing director and global head of research; Jonathan Mazur, executive managing director of national research; and Mike Wolfson, managing director of multifamily markets research.

Lending is down sharply, a decline of 52% in the first half of 2023 compared to the same period of 2022, and down 31% from pre-pandemic levels, Newmark reported. The firm noted that there are 32% fewer active lenders in the market today than there were a year ago.

While the amount of dry powder raised by closed-end funds rose to a record $261B at the end of the second quarter, Newmark noted investors were focused mainly on residential, industrial and some niche sectors like healthcare, self-storage and senior housing.

That dry powder hasn't equated to more deals, as sales were down 62% year-over-year in the first half of 2023, and dropped 12% between the first and second quarters. Sales were down 30% compared to the three-year, pre-pandemic average.

All of commercial real estate has been vulnerable to the uptick in interest rates, office values have been among the most impacted as landlords experience a seismic demand shift with hybrid work, rising layoffs and uncertainty among companies on just how much office space they actually need.

Newmark estimated that 16% of the national office market — nearly 1B SF — is economically unviable or obsolescent because the buildings are less than 70% occupied. Another 618M SF is unable to service its debt because occupancy is between 70% and 80%.

Recently, London-based research firm Capital Economics predicted that office values could plummet 35% by the end of 2025, with net operating income shrinking below 2019 levels through the end of the decade. That could have landlords face the prospect that office values won’t likely recover even by 2040.

Bitner told Bloomberg that depressed office values likely will force overleveraged borrowers to give back the keys to lenders instead of trying to refinance at higher costs.

"They’re going to have every incentive to hand back the keys to lenders," Bitner told Bloomberg. "I’m shocked that hasn’t happened a lot more."