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Flood of Debt, Opportunity Hits CRE
January 23, 2014
Remember the debt tsunami? That was the huge wave of commercial mortgages made during the real estate boom that would crash the real estate market when they hit the end of their loan terms. The first wave of short-term loans passed by in the early years of the recovery without causing as much damage as feared. Now the second wave of long-term loans is nearing, starting in 2015.
Some experts still worry that borrowers will have trouble refinancing these long-term loans and may eventually default—but the prognosis for many borrowers is surprisingly hopeful.
“People have begun look at these loans as opportunities rather than threats,” says Jamie Woodwell, senior vice president for the Mortgage Bankers Association. “Borrowers now can go out and get a great interest rate.”
Pre-payment penalties locked many borrowers into relatively high interest rates for long-term loans that they took out during the real estate boom. As the loans approach the ends of their terms, these pre-payment penalties are finally going away, giving borrowers the opportunity to refinance at the relatively low interest rates still available.
An estimated $1.4 trillion in commercial mortgages will mature between 2014 and 2017, according to “Maturing CRE Loans: The Outlook for Refinancing,” a recent report from Trepp.
“With the large volume of loans maturing between 2014 and 2017, including many that were originated at the prior market peak in the mid-2000s, current market conditions may create trouble for borrowers seeking to refinance loans,” according to Trepp.
Some loans coming due in the next few year will face problems, either because the value of properties have still not recovered from the crash or because underwriting standards, in particular the “stressed loan-to-value” ratio used by bond rating agencies, have gotten tougher since the last real estate cycle.
However, commercial properties have recovered much of the value they lost. Depending on which commercial property price index you look at, values are now 15 percent below their peak or are breaking even, says Woodwell. That’s a strong improvement compared to the unanimously sour story told by the indexes a few years ago. Net operating incomes are also strong for multifamily, retail, and even office properties, according to figures from the National Council of Real Estate Investment Fiduciaries, though incomes from industrial properties continue to hang below peak levels.
Interest rates are also much lower now than economists predicted they would be a few years ago. That’s great news for long-term borrowers, who had every reason to fear that by the time their loans hit the end of their terms, interest rates would be significantly higher than the rates on their current financing. “Everyone anticipated rates rising and rates went down for years,” says Woodwell.
Rates have risen recently, but the yield on ten-year Treasury bonds is still now around 3 percent—still significantly less than it was during the boom years, when the benchmark yield mostly hovered in the 4 percent range.
Also, as these loans approach the ends of their terms, the finance markets are finally healing to the point that lenders may now be able to supply the necessary liquidity. Conduits lenders are quickly growing their business as bond issuers churned out $85 billion in commercial mortgage-backed securities in 2013, says Woodwell. That’s still less than needed, but it’s now conceivable that when loan maturities peak in 2017, the finance markets may have enough capacity to handle the flow of deals.
“There are a whole range of lenders out there who are very eager to finance properties,” says Woodwell.
That flow of refinancing deals should begin in the next twelve months, as the pre-payment penalties begin to ease on 10-year loans made during the boom years. The actual term dates on these loans generally comes a year or two after the prepayment penalties ease. In 2014, the volume of loans hitting the end of their terms will sink to a low point of $115.6 billion, rising to $178.6 billion in 2015, $212.8 billion in 2016, and 213.3 billion in 2018. In 2019, the volume of loans maturing recedes to $73.1 billion.
With this much volume of demand for refinancing, there is still a lot that could go wrong, however. Properties in weak markets or difficult narratives that may scare away lenders should start planning now. A spike in interest rates could also change the prognosis for many of properties seeking refinancing.
“Borrowers should definitely look into it… both if there are risks and is there are opportunities,” says Woodwell.