Coming Home To Roost

Doug Marshall
Market Assessment
Published July 6, 2009

The numbers are alarming… probably because they’re simply so huge. And for some reason, the conversation about this doesn’t seem to be happening.

While most attention in commercial real estate today is focused on the dramatic deterioration in term loan performance (i.e. defaulting loans), an even more troublesome issue is the extent to which loans originated during the 2005-2007 period will encounter significant problems, refinancing at maturity.

A report dated April 22nd, from the prestigious Deutsche Bank Securities research group, focused on this refinancing issue. Shown below is a chart showing the annual maturities of loans by lender classification.
The conclusions drawn by Deutsch Bank Research are manifold, and are a great cause for unease:

· Commercial real estate prices have already plummeted 25-30% from their peak in 2007 due to the enormous changes in available financing terms (lower LTVs, higher interest rates, etc).

Further declines may be expected based purely on the degrading economy (which is resulting in higher vacancy and lower rental rates), pushing values down another 15-25%.

· The decline in commercial real estate values in the 2005-2007 period will make it very difficult for many properties to refinance when their loans come due.

They predict that two thirds of the loans maturing between 2009 and 2018 ($410 billion) are unlikely to qualify for refinancing at maturity without significant equity infusions from borrowers.

· This group estimates that the equity deficiency that would have to be made up by borrowers themselves tops $100 billion.

Solutions that have been floated to solve this problem seem, at best, naïve. One idea that has been presented is that banks and other lending institutions facing this refinancing wave will simply agree to extend the maturity dates.

This incorrectly assumes that either: 1) the lender, by shortening the amortization of the loan, will sufficiently help accelerate the pay down of the loan; or that 2) extending the loan term provides the property time to achieve additional growth in value so the loan can qualify for refinancing.

With respect to the first possibility, the report concludes that the value deficiency for many loans is far too large to be tackled by simply accelerating the amortization over a reasonable time period. And with respect to value growth, the likelihood of significant property price appreciation is remote.

It’s a gloomy forecast. We strongly encourage borrowers to determine whether any of their loans are currently “upside down.”

This can be determined simply by taking current interest rates, cap rates, and underwriting terms to calculate whether their new loan would qualify for refinancing at more or less than the existing loan amount.

If the new loan is less than the existing loan you’ve got a problem; and now is the time to start working on a solution, not when the loan is due.

If you or a client of yours would like help estimating a new loan for their property under today’s lending criteria we are ready to assist you. Please do not hesitate to contact us for a no-obligation loan estimate today.

Source:
Potential Refinancing Crisis in Commercial Real Estate, April 22, 2009, by Deutche Bank Securities, Inc.