The Coming ‘Wall’ of Maturing CRE Loans – A Perfect Storm?
- Jan 07, 2015
After the 2008 market collapse there were many gloomy predictions about the impact of maturing commercial real estate loans. The hand-wringing has subsided as the economy has recovered, property values rebounded to pre-crash levels, and interest rates remained at historic lows. Much of the CRE debt maturing in 2011 through this year has been absorbed without causing a wholesale market collapse.
This “soft landing” has given rise to a false sense of security that the worst is behind us. The coming “wall” of more than $1 trillion of maturing commercial real estate loans from 2015 to 2017 is likely to be confronted by a range of challenges that could combine to cause a “perfect storm”:
- Many Maturing Loans are Over-Leveraged. About 25 percent of the loans maturing in the next three years consist of 2005 to 2007 vintage 10-year CMBS loans, many of which were very aggressively underwritten at the top of the market. A recent Trepp study indicates that the current LTV and DSC ratios of the majority of these maturing loans falls short of current CMBS market underwriting parameters. Borrowers will need to infuse equity or incur expensive subordinate financing in order to refinance if they want to keep their properties. Worse, a significant portion of these maturing CMBS loans have LTV ratios exceeding 100 percent (i.e. negative equity), which could trigger another round of distress.
- The CMBS Market Can’t Absorb the Refinancing Demand. The CMBS market has recovered to approximately $80 billion to $90 billion annual volume, well short of the annual $110 billion+ of CMBS loans maturing through 2017, meaning that borrowers will need to rely on other lending sources.
- Banks Face Increased Regulation Limiting CRE Loan Demand. Banks comprise about 50 percent of the wave of maturing loans. New regulatory requirements phasing in under Dodd-Frank and Basel III make it more costly to hold CRE loans in terms of required minimum capital reserves and liquidity. As a consequence, banks will likely constrict both CRE loan renewals and new lending. Consequently, borrowers will need to turn to alternative sources.
- Valuations – More Downside than Upside. Since bottoming out in 2010, CRE property values have rebounded, particularly institutional quality assets in gateway cities. In some cases, values now exceed pre-recession levels. There is some question as to the sustainability of this trend, which is now in its fourth year. If values flatten or decline, that will create problems for borrowers with maturing loans.
- Interest Rates (and Perhaps Cap Rates) Will Rise. Most economists agree that interest rates will rise within the next three years. This may translate to higher cap rates and therefore, lower valuations. Further, senior mortgage underwriting will likely tighten as deals become more debt- service constrained.
Savvy borrowers should certainly look to refinance or recapitalize now while rates are at historic lows and capital is abundant, before these factors combine to cause a credit crunch. Otherwise, we will all be in the same boat together, waiting for the “perfect storm.”