Commercial real estate sponsors with maturing loans who were hoping to buy time and wait for a more favorable interest rate environment are coming to terms with the reality that interest rates are not going to moderate anytime soon, according to lenders and borrowers who spoke with Real Estate Capital USA.
The sentiment is one that has gained traction over the past few weeks, with the market coming to the realization that the problems around maturing loans or other issues in the capital stack can no longer be put off, said Nitin Chexal, chief executive of Palladius Capital Management, an Austin, Texas-based real estate private equity manager.
“As a lender, the question we think about when evaluating borrower execution plans is whether they should defend their position and hold on to the property or negotiate to modify a loan,” Chexal said. “That optionality exists for groups that are well capitalized. But for other groups, they are at the end of their ropes and have run out of time.”
The concept of buying time has been a key theme in the commercial real estate markets since the start of 2023, with lenders and borrowers working together to stave off defaults and delinquencies with a wide range of strategies. These strategies have included the use of bridge loans, in-the-money interest rate caps, pay and accrual loans and a newly minted blend and extend strategy through which lenders will adjust the rate on a loan in exchange for additional collateral.
Michael Lee, a partner at New York-based advisory HKS Real Estate Advisors, said the firm is starting to see a shift in the way the borrowers with near-term maturities view these liabilities.
“When it comes to loan maturities, we are seeing the impact of major life-changing moments like partnership disputes or institutional equity player whose fund is expiring. I think people will continue to make those decisions out of necessity,” Lee said. “If you’re a borrower in a distressed situation with too much leverage and are up against the fence, you’ll have to transact.”
Signs of movement
While the change in sponsor attitude has not yet been reflected in transaction volume, market participants are pointing to anecdotal situations over the past 30 to 60 days which shed light on the shift. In his conversations with investment sales brokers, Chexal has heard there has been a significant increase in the number of requests for broker opinions of value, because sponsors need to start thinking more seriously about maturing loans.
“For our equity investment strategies, there will be a healthy opportunity to acquire assets at attractive valuations or to acquire existing debt at a discount to par and help sponsors to recapitalize their assets,” Chexal said. “There is a sense that it is time to go and to move ahead.”
HKS Real Estate Advisors, which tracked a significant drop in transaction volume in New York in the third quarter of 2023, anticipates this will start to reverse course, albeit slowly, in the coming year. In addition to a wall of maturities that New York-based data provider MSCI pegs at about $1.9 trillion through the end of 2026, there are other factors at play, Lee said.
“I don’t know if the [expected sale of the] Signature Bank portfolio will force anyone’s hand, but it could set a precedent for what these properties are worth and what people are willing to pay,” Lee said. “I think everything will be driven on a need-to-basis, like loan maturities or partnership issues.”
According to HKS Real Estate Advisors’ Q3 2023 report, there were just $3.94 billion of transactions for the quarter in New York, a dip from the $5.33 billion seen in the second quarter and $5.32 billion tracked in the first three months of the year. These levels are, of course, significantly below the norm, Lee adds.
“It feels like we have hit the low point in terms of transaction volumes, and it is not going to fall further. A lot of what we are doing right now is running in place. But we are having conversations with sponsors in which we are going through numbers, portfolios and buildings and putting together a game plan for what needs to happen going into next year and into 2025. The borrowers need to understand what their options are and understand what it means to go to the market today.”
Ben Miller, chief executive of Washington, D.C.-based online alternative asset manager Fundrise, is expecting to see an increase in transaction volume in the coming months but cautioned that it could be years before there is meaningful activity.
“An increase in transaction volume is something that everyone is always talking about but very little is actually seen. It is hard to put money out when Treasuries are elevated and prices are depressed,” Miller said.
He continued: “After the start of the global financial crisis, the market was not back to full health until 2011. This current disruption started in 2022 and it is not likely that things will meaningfully improve before 2025. While the distress today is not as severe as what we saw in 2008, it is important to remember that markets don’t immediately turn on again – they go sideways before they go up.”
The multifamily factor
There is a particular story around what is going on in the multifamily sector, with market participants pointing to the number of these properties that were sold in 2020 and into the first part of 2021.
Bert Crouch, managing director and head of North America at Dallas-based manager Invesco Real Estate, told Real Estate Capital USA, in a story published in November, that he believes the wave of maturing bridge loans and interest rate caps will be the biggest catalyst on floating-rate driven distress in the near-term.
Richard Litton, president of Norfolk, Virginia-based real estate private equity manager Harbor Group International, said: “If you think back to late 2020 and 2021, you will remember that was a very robust time for the multifamily markets. Cap rates were very low and the SOFR index was, for all intents and purposes, zero. There was a tremendous amount of transaction volume.”
Many of these buyers were using floating-rate debt from debt funds that had an initial three-year term. But as these loans start to reach the end of their initial term and the borrowers look to extend, they are often finding the cost of buying a new rate cap is prohibitively expensive, Litton said.
“We are starting to see the first wave of those initial maturities expire and there is a very significant volume of that dynamic that will start to mature in 2024,” he said. “We are getting to the point of more actual maturities occurring.”
In addition to maturing loans, there are other factors that could spur transaction activity.
Litton also sees a scenario in which the long-term impact of higher rates is making it too difficult for owners to keep loans current and execute their business plans.
“The pressure of this elevated rate environment for floating-rate debt is crimping the cash flow of properties. It has kept people that would have underwritten to spend a certain amount of cashflow to renovate properties from doing that because all of that cash is now going to debt service and is eroding the operations for some owners.”
For HKS, the paucity of transaction volume over the past 12 months is tied to the restrictive impact of monetary policy, Lee said. But loan maturities, distressed situations and opportunistic buying will be a driving force in regaining momentum.
“I don’t think transaction volume will ramp back up in the short term, but we will start to see opportunities. People have been saying, ‘I’ll do the deal later, when rates come down,’ but a year and a half later, rates have not come down. Owners will have to make a decision regarding that property they have been sitting on for 18 months, or a loan where there are issues. Time is up and people need to move now.”