The numbers around maturing commercial real estate loans over the next few years are well-known. There is, however, a specific subsegment of the market that could face additional distress: 10-year interest-only commercial mortgage backed securities loans on small and mid-market properties.
“The next wave of distress is going to be caused by maturing loans that are performing, but not outperforming as was modeled,” says Keyvan Ghaytanchi, chief investment officer of Port Washington, New York-based investment manager BEB Capital. “This is true for small- to mid-sized managers, who will see distress emerge when these loans need to be refinanced, even if we are in a more normal rate environment.”
In a July report, New York-based analytics provider Trepp projected $103 billion of CMBS maturities in the second half of 2023. There is another $126 billion slated to come to in 2024, with additional commercial real estate CLO loans and agency debt. In all, there is more than $310 billion of loans maturing through the end of 2024.
“A significant amount of loans were originated in 2013 and 2014 when lending conditions were favorable and will be nearing the end of their underwritten 10-year terms. Others are 2011 and 2012 vintages, which have either been extended on a short-term basis after entering special servicing or had a series of extension options written into the loan terms that have been exercised,” says Jack LaForge, a senior vice-president at Trepp.
The firm believes the loans most at risk are those originated in 2013 and 2014, when the average rate at origination for fixed-rate loans was close to 4 percent. “In 2023, the average fixed loan rate is originating at 6.5 percent, meaning that borrowers who wish to receive a new fixed-rate loan will have to contend with higher interest expenses,” LaForge adds. Further, a substantial number of these CMBS loans were originated on an interest-only basis – so the sponsor will have repay the full amount at maturity.
Mid-market’s missing money
Stuart Rich, a senior managing director at advisory Black Bear Capital Partners, believes the issue will be compounded by less capital being allocated to small- and mid-market deals.
“We all read about the big deals that are getting done, but middle market deals are not. I wouldn’t say it is from a lack of capital, but there is a lack of desire to deploy that capital at rates where the borrower perceives as fair and what debt funds need to achieve proper returns and be secure,” Rich adds.
Part of the problem is a market in which many participants have never operated in a rising rate environment.
“If you have only valued deals in a near-zero rate world, it takes some re-training of your process to understand what values and cashflows might be,” Rich adds. “People who bought a property at 3.5 percent in 2013 and now have to refinance at 6 percent can’t get their heads wrapped around that the rate is so much higher. This is a reaction on the sponsor side as well as the lender side.”
There is still a disconnect between what borrowers, lenders and the market thinks the properties are worth, which will make the process more difficult, Rich believes. “There is more focus now on what is coming due and, if you look at how many IO loans were in CMBS, we’re going to see people who have to write big checks to refinance those properties or find rescue capital.”