LENDING PREDICTIONS AMID BANK CRISIS FOR CRE IN USA

BY Realty Plus

The US commercial real estate (CRE) market is facing a double barrel challenge of rising interest rates and a large volume of loan maturities in 2023.  For the office sector of the CRE market this problem is exacerbated by high vacancy rates that took hold during the pandemic but pre-Covid occupancy levels have not returned.  Multifamily is another sector of the CRE market that is under stress, especially in urban markets like New York, San Francisco, Los Angeles and Chicago.    

The Boston Metro area seems to be a bright spot given that the office demand comes from more resilient industries like research and technology.  Despite all of the bad news, rating agencies are not seeing the impact show up in the commercial mortgage-backed securities (CMBS) remittance data, yet.   Meanwhile, commercial real estate investment trusts (CRE REITs) are said to be sitting on the sidelines with dry powder ready to snap up bargains.  

According to TREPP, $448.2 billion in commercial mortgage loans are set to mature in 2023 and 60% of those loans sit on bank balance sheets. Unlike a residential mortgage, in CRE lending there is a mismatch between the loan term and the full amortization term.  

CRE loan terms typically range from 5 years or less to 20 years but the amortization period is longer, say 30 years, therefore at the end of the loan term CRE borrowers will have a balloon payment that some borrowers pay but many larger notes are refinanced.  

Borrowers are trying to refinance loans in a rising interest rate environment; where banks have tightened their underwriting standards and reduced their appetite for certain CRE sectors like office and multifamily.  

The CRE office sector is struggling the most and has not recovered from high vacancy rates brought on by nationwide work from home routines put in place during the pandemic.   

The original conditions at loan origination like the presence of an interest rate cap; debt service coverage ratio; recourse to the borrower; built in term extensions; and the amount of equity in the property matter and will positively or negatively influence a borrower’s options and ability to refinance.  

While real estate dynamics are certainly regional, some urban centers are struggling more than others.  According to the Wall Street Journal, in San Francisco a $300M office building on California Street is up for sale and the property value has dropped by 80% in the last 4 years.  The building is currently owned by the Japanese bank MUFG. 

Unfortunately for San Francisco, a city plagued by high rates of drug addiction and homelessness, MUFG is the largest taxpayer in the city.  In Manhattan, New York City’s most expensive borough, Blackstone is in danger of defaulting on a $270 million non-recourse loan backed by 11 apartment buildings.   

The private equity firm and mortgage REIT doesn’t have enough cash flow from rents to cover debt service and maintenance costs.  The portfolio, backed by older buildings, had to be transferred to special servicing.  Unlike Manhattan which has a high concentration of multifamily real estate and office tenants in the financial services and professional services sector, the Boston Metro area benefits from demand diversity.  

The education, technology and research industries have sustained Boston’s office sector through the pandemic and CommercialEdge data shows that life sciences buildings account for 13.7% of existing inventory and 54.8% of office space under construction.  

First quarter CMBS performance metrics have not shown a spike in delinquencies or defaults but remittance reports are admittedly backward looking.  S&P runs the numbers on refinancing risk and points out that borrowers coming to the market seek to replace current coupons ranging from 3.0% to 5.0% with that of 6.0% - 8.0% in the current market environment. Transfers to special servicing, another indication of trouble in the market, have increased to 4.8% in March for the overall CRE market and office transfers are up nearly 100bps since the end of last year. 

The New York office sector looms large in the CMBS market as well and at 39% it has the largest concentration of loans set to mature soon. The market will continue to monitor CMBS performance very closely from now until 2027 when according to Trepp over $2 trillion in CRE loans will mature; however, CMBS has the lowest exposure to this cohort at 6.5% compared to banks (54.9%), insurance companies (9.5%), GSEs (16.8%) and alternative nonbank lenders (12.2%).  

In mid-April, Moody’s downgraded the Macro Profile of the US banking system to Strong+ from Very Strong- and noted a trend of some banks experiencing negative pressure on earnings, weaker capitalization and default and delinquency risk posed by commercial real estate.   

While banks like Wells Fargo have reported increased loan loss reserves due in part to their exposure to the CRE office sector, non-bank lenders like CRE REITs are ready to step up to the plate in anticipation of traditional lenders pulling back their exposure to the sector.  

Trepp looked at 13 national commercial mortgage REITS and noted that they reduced CRE mortgage originations by 40% since 2021.  Estimates show that REITs have more than $15 billion in available liquidity to enter the market and using typical 2x leverage estimates provide more than $30 billion in buying power.  

Overall, the story of the commercial real estate market is still being written as national and global economic factors are still unfolding and local US markets that are diversified or have minimal exposure to the most distressed sectors will likely weather the storm.

Tags : predictions bank crisis CRE USA