Summary
The paucity of refinancing available for commercial real estate properties has massive implications for banks, CMBS investors and commercial real estate equity values. The sheer volume of commercial real estate mortgages coming due in the next 24 months that will not be able to obtain refinancing is staggering. Opportunities will be great in both lending and equity ownership for entities with clean balance sheets and patient capital. On the flip side, troubled institutions and/or those with impatient capital sources are going to face mounting troubles.
Analysis
As noted in the article, some $400 million of loans packaged into CMBS will be coming due in the next few years, and perhaps two-thirds of these loans could face trouble refinancing. As troubling as this may be, loans underlying CMBS account for well under half of all commercial real estate loans (the article says 25%, but I would be surprised if it is truly that low). Furthermore, the majority of the loans that are not packaged in CMBS are held mostly by banks, usually in the form of floating-rate, relatively short-term loans. These loans are typically three-year loans while the typical CMBS loan is a ten-year loan with a fixed interest rate. Now for the really troubling news: since the vast majority of the short-term loans now outstanding were originated in 2006 or later, these loans were originated in perhaps the most aggressive underwriting environment ever (i.e., highest loan proceeds as a percentage of value, most aggressive valuations, lowest reserve requirements, lowest interest rate spreads, etc.). Accordingly, even if they have performed as underwritten (which is unlikely given the economic environment), they almost certainly will not support refinancing proceeds in the current market anywhere close to the amount required to pay off the maturing loan.
In many cases the only financing available to either the current borrower or a take-out borrower (i.e., a new owner taking over the troubled asset) will be the existing lender, but such refinancing will only happen where the lender is both willing and able to make a new loan. In the case of CMBS loans, this option is less available under REMIC rules. As a result, the market can expect to see a very high volume of unwanted or forced transactions with limited financing to go alongside the equity capital that has accumulated to take advantage of market opportunities. The seemingly inevitable result will be that cap rates will increase to the point that appropriate equity returns can be attained with very conservative levels of equity; this is when actual transaction valuations will begin to converge with implied or expected valuation levels. The biggest losers will be the entities in must-sell situations because of impatient capital. The well-positioned players, especially those with true staying power, will see terrific opportunities.
