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Unlike residential loans,
which are self amortizing,
commercial loans typically
have a balloon or call
provision requiring the
borrower to refinance or pay
off the loan at a certain
date in the future,
typically 5 or 10 years.
Between now and 2013, $1.3
trillion in commercial loans
- for property types like
shopping centers, office,
multifamily, industrial,
hotel and self storage - are
coming due. According to
Deutsche Bank, at least half
of the maturing commercial
and multifamily debt will
not qualify for refinancing.
And worse yet, two-thirds of
CMBS debt will not be
eligible for refinancing
resulting in losses on
securitized commercial
mortgages of $50 billion;
compared with $200 billion
on conventional commercial
real estate loans.
The Federal Reserve and
Treasury Department are
considering a number of
options including providing
incentives to banks to
extend the maturity date of
the commercial real estate
loans in an effort to
minimize damage. The
alternative, more bank
losses, more bankruptcies
and plunging commercial real
estate values.
Take for example General
Growth Properties, the
nation's second largest
shopping mall owner. General
Growth Properties was unable
to refinance many of its
commercial mortgages - even
though many of the
properties have positive
cash flow - and was forced
to
file bankruptcy.
With sales prices down as
much as 45% from the peak in
2007, rapidly increasing
vacancies and tighter
underwriting guidelines,
even the strongest
commercial mortgage
refinancing candidates are
having difficulty resetting
the terms of their loans.
And the fundamentals will
only get worse going
forward. Vacancies are up —
expected by year's end to
reach 13.5% for retail and
17% for office buildings —
cutting potential income
that commercial properties
need to make their mortgage
payments.
Add to that the threat of
impending inflation - which
means higher interest rates
and more income required to
service the debt - and the
outlook looks bleak. But
higher rates, higher
vacancies and lower income
available to service debt
are only part of the
equation.
Over the past 5 or more
years underwriting standards
were loose and commercial
lenders were loaning up to
90% - and in some cases 100%
- of a property's appraised
value. Lenders justified
over leveraging properties
simply because the thought
was rents would continue to
rise and cap rates would
continue to fall, eventually
bringing values and debt
service coverage ratios
(DSCR) inline with
traditional underwriting
guidelines. Now, lenders are
underwriting to much lower
loan to value ratios (LTV)
disqualifying borrowers from
refinancing even with
stabilized performing
assets.
The Federal Reserve and
Treasury Department are
considering including
commercial real estate loans
in
TALF which could
help reduce defaults and
bank losses. Additionally,
there is a great deal of
lobbying by real estate
executives for more direct
government incentives to
encourage banks to extend
the terms of loans coming
due. Subsidizing the
interest rate and paying a
fee, e.g., one percent of
the loan amount, so banks
can earn more revenue on a
commercial real estate loan
are two options being
discussed.
While losses on commercial
real estate loans are
relatively low at this time,
increasing delinquencies,
higher vacancies, lower
consumer spending and a
continued deterioration in
the economy spells trouble
ahead. Delinquencies for
CMBS debt are around 1.7%
today and are expected to
increase to 3% by years end
and as high as 6% in 2010.
To put it into perspective,
current residential
delinquencies are in the
6%-7% range, so it's easy to
understand the troubles that
are brewing for both the
commercial real estate
sector and the US economy.
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