The looming mountain of loan maturities has cast a tall shadow over the commercial real estate market for the past several years. But instead of an avalanche of highly-leveraged loans hitting the market, what has materialized is more of a slow-moving glacier that is melting away.
Initial concerns about financing that heavy load of maturing debt were valid. Loan issuance hit record-high levels in 2005, 2006 and 2007. For example, CMBS issuance during that three-year span totaled nearly $600 billion, according to Commercial Mortgage Alert. The recession took its toll on liquidity and property values, and people were left wondering how much of that debt would be underwater and whether or not borrowers would be able to recapitalize those highly leveraged loans.
Many of those fears dissipated as lenders returned to the market along with what has become a prolonged low-interest rate environment. Access to capital and improving property values have helped the industry chip away at the mountain of maturities. The GSEs grew into a massive force in financing the multifamily industry. The life companies continued their strong lending, and banks both large and small added term loan debt to the market. The volume of loans set to mature in 2016 and 2017 has been reduced dramatically as borrowers took advantage of favorable financing to defease loans and refinance early. Yet the market isn’t entirely out of the woods. There is still a sizable amount of aging debt still hanging over the market with an estimated $391.70 billion in maturities of commercial and multifamily mortgages held by non-bank lenders and investors in the next two years.
Most of the long-term, fixed-rate loans done in the past cycle were priced in the 6 percent range; today rates of 4 percent are common. The reduced interest rates have allowed borrowers to approach lenders for a blend-and-extend or some type of discounted prepayment if they are able to modify the loan and commit to a longer term.
For example, NorthMarq Capital had a client with a well-leased office property in Northern California that had an existing loan with a life company at a rate that was above 6 percent and 18 months left to maturity. The borrower refinanced with the existing lender at a low 4 percent rate with additional proceeds provided. In that case, the rate was slightly higher than a new loan but still significantly discounted compared to the full pre-payment premium. Still others have found that paying full prepayment has been beneficial in order to refinance early with current low rates.
The CMBS maturities that remain are often higher LTV or problematic loans that face some hurdles in obtaining financing, whether that is an issue with the property, the sponsor or the market. Notably, there is still a concentration of loan maturities in specialty uses, retail and office properties, as those sectors have lagged in the recovery compared with multifamily and industrial. Retail remains a challenge due to the business risk as retailers continue to struggle with store closings. Office is more of a market-by-market issue as some cities have not recovered as strongly as others.
Some of the retail and office properties that have issues with leasing, design or market fundamentals are going to require more creative financing solutions. That is where opportunistic capital comes into play, offering higher priced bridge and mezzanine debt and preferred equity. This capital is willing to take a risk on repositioning a property, or market risk in a secondary or tertiary city. For example, many such loans are being taken out with three-year bridge loans at higher floating rates with the expectation that the problems will be resolved and the property refinanced later in the future.
The good news is that there is liquidity in the market and there is seemingly a home for nearly every asset. Lenders continue to have money to place. The bad news is that, at some point, the higher cost of available capital (mezzanine or preferred equity) for some properties may squeeze out all of the value, making it difficult for the existing owner to hold onto the asset.
The best advice for borrowers is to prepare at least 12 months before the loan maturity date by consulting with your trusted advisors to look at a wide variety of options in the current marketplace. Oftentimes, the existing lender is willing to offer a leading deal in order to retain the loan, but that is not always the case. It is important to develop options and create the right “market” for your financing so you wind up with the best capital for your needs. If you wait too long, you will likely have less leverage and less flexibility.Download PDF