According to research firm Trepp, some $360 billion in commercial real estate loans are maturing this year and more than 60 percent are underwater. Of that total, $53.4 billion in CMBS loans are coming due this year, $15.5 billion of which were vintage 2007 loans, 27 percent of which are in special servicing and 18.5 percent are 30 days or more delinquent.
According to a Morningstar report, “By property type, the greatest future risk exposure by unpaid balances is found in office collateral, while retail collateral is by far the largest by loan count.” At a recent Commercial Real Estate Finance Council (CREFC) conference, panelists reported that 20 to 35 percent of CMBS loans originated in 2007 will probably be refinanced, with the balance facing significant equity shortfalls of 25 to 40 percent, likely to result in forced asset sales by lenders and borrowers.
A grim and gloomy picture? Heck, no! Michael Riccio, senior managing director and co-head, national production/debt and equity finance, at CBRE Capital Markets, noted that there was considerable optimism among the life insurance companies, conduits and banks who attended the CREFC conference, though some were more cautious than others.
“The life insurance companies are licking their chops, ready to have another great year,” noting that these companies are envisioning $60 billion in loans this year. “They can pick their spots, go for larger transactions.” Banks are also looking to lend in gateway cities and other top markets, he said. As for 2012 CMBS new volume projections, they ranged from $25 to $60 billion, with most in the $35 to $40 billion range, said Riccio.
Riccio himself estimates that of the commercial loans maturing in 2012, perhaps 30 to 40 percent will be able to be refinanced, while the rest will have to be modified. CMBS loans originated in 2002 are generally financeable, he said, but the 2007 vintage will be more difficult because 80 percent of those loans were based on future rent projections. These will need restructuring or recapitalization.
"We’re still working through the deleveraging process. That will take a number of years. There’ll be a little bit of pain, still,” noted Riccio.
One important factor is whether or not investor demand is going to be strong enough in the CMBS market. According to Riccio, there’s no problem with either the top-rated or the very bottom-rated tranches. “It’s the soft middle that’s the problem, which reflects the real estate market,” he said. For a 75 percent leased office outside of Cincinnati, as a hypothetical example, he said, it would be difficult to get financing on a non-recourse basis. “If you refinance, you’ll probably need a little recourse and additional equity. If you purchase, look at 60 percent loan-to-value at the most.”
He added that there is plenty of mezzanine money available, in a wide variety of structures and requirements. Some loans are at interest rates of 11 to 13 percent, covering up to 80 percent of the capital stack. Others cover up to 60 to 70 percent of the capital stack, at seven to eight percent interest rates. Some are in the $5 to $15 million range, others up to $50 million. Perhaps not surprisingly, Riccio expects the mezzanine business to grow this year.
For Borrowers, Still a Tale of Two Cities
William E. Hughes, senior vice president and managing director, Marcus & Millichap Capital Corp., commented that refinancing is challenging because despite the fact that there is confidence back in the market in terms of valuation and underwriting, it’s still a “tale of two cities.” That is, there is plenty of capital in the major markets but more caution everywhere else.
What if you have a loan coming due on an office or industrial property in a non-major market, say, in the Midwest? Hughes advised looking to smaller life insurance companies and local lenders. “If you don’t have smaller commercial banks in tow, it’s a challenge. If there is a positive reaction to new CMBS issues, then there will be financing available in the B- to C+ arena,” Hughes predicted.
Even when capital is available for office and industrial properties, each property must be looked at individually; everyone is cautious about tenant risk (including lease rollovers) and underwriting is critical. Micro-markets are “all over the board” in leasing trends, rates and occupancy levels. That said, depending on the asset class and the lender, refinancing could be for terms of three to seven years, at 2.25 to 3.50 over LIBOR, so interest rates would be in the mid-to-high four to six percent range.
Will borrowers seeking refinancing be required to invest new equity? In some instances, yes. Other options include cross-collateralization of assets and recapitalizations. Marcus & Millichap has helped clients get some extensions, but Hughes reported that “We’re finding lenders less willing to do that.” Depending on the valuation, lenders might offer a three-month extension and require the borrower to come in with equity to restructure the loan, or turn over the keys.
Hughes noted that bigger deals are easier to do because they can attract a fund’s interest, adding that for $1 or $2 million, it’s a lot more challenging.
Looking ahead, Hughes said “I’m pretty confident that what we’re seeing now is what we’ll be seeing a year from now. Even the election year won’t impact us as much as it used to. The economy is choppy, there is not exceptional job growth and we’re not out of the woods with the European debt crisis (or our own). We’re going to have to do some restructuring, with new capital coming in.” There are multiple answers, including new ownership, or funds’ providing mezzanine/preferred equity. Like many industry observers, Hughes believes that some banks will be willing to write off assets.
“But I want to stress that there won’t be blood in the water. Values are too strong; there’s too much capital in the market, he commented.
Out with the Old! In with the New!
Standard & Poor’s is forecasting $35 billion in new CMBS volume this year. In the ratings firm’s podcast, Jim Manzi of the firm’s structured finance research unit noted that “Until the European debt crisis improves, the regulatory environment is clarified and demand for below-triple A bonds picks up, it’s hard to see above the range of $40 billion in CMBS volume.” He remarked that with new regulations affecting banks, “We may see some non-bank originators increasing in market share” in CMBS issuance.
Fitch Ratings’ U.S. CMBS Market Trends newsletter reported that issuers at the CREFC annual conference had optimistic forecasts and that the major ones hoped to close one deal per quarter this year. Most agreed that underwriting standards have remained fairly disciplined and were generally comfortable with the properties in recent transactions despite not being “A” quality.
One recurring negative note, the newsletter reported, was “the distrust by market participants of what the special servicers may do next regarding loan modifications and/or fair market value determinations. This is a topic that Fitch Ratings expects to be a continual theme for the year, as loan resolutions and/or modifications continue.” Should underwriting standards decline, Fitch asserted, credit enhancement levels will increase. As for performance of existing transactions, delinquencies are expected to fluctuate; Fitch stated that downgrades will be mainly prevalent in already-below-investment grade classes, with the exceptions being further value declines in specific assets representing a large portion of a transaction.