Lenders Asking for More Equity to Refinance CRE Loans


Commercial real estate property owners might not have enough equity to refinance their properties as loans originated in 2007 become due throughout this year, warns one expert.

Michael Hartman, director of Reznick Capital Markets, said, “We’re sitting on a massive bubble of commercial real estate refinancing that is getting ready to burst. Five years ago, people borrowed too much. Today, those loans are maturing but now there isn’t nearly as much available working capital and fresh credit for commercial real estate projects.”

According to an analyst report from Keefe, Bruyette Woods, commercial mortgage originations this year should be driven by refis “as there is currently $3.1 trillion in commercial mortgage debt outstanding, a significant portion of which will be maturing over the next few years.”

In the three years before the market meltdown in 2008, many property owners took advantage of “generous credit markets,” Hartman explained, with most of the loans during the period having maturity dates of five years or seven years.

Many borrowers back then took loans with loan-to-value ratios in the area of 80% to 90%. However, in many cases, property values declined, and similar to residential property owners, commercial property owners were unable to build or even lost equity in their holdings.

These loans are coming due, and refinancing into a new loan is going to be difficult, Hartman said, as lender criteria has tightened to where the LTV range is now in the area of 60% to 70%.

That gap will require real estate owners to come up with new equity to reach the new LTV target, but he continued many of them do not have the money to do so.

There are some options; the lender can “quick the can,” where the lender acknowledges the original loan term has expired and the borrower cannot get new financing, so it extends the existing loan for a year or two and revisits the problem then hoping things have improved, he said, adding this is what is happening in a lot of cases.

The second choice is that the original lender ends up taking “a discounted payoff.” Hartman explained this is where the borrower obtains a new loan but for an amount less than what is owed. The lender charges off the difference.

Then there is the last resort—because the borrower did not repay the loan when due, the lender can foreclose on the property. But that option is not desirable either because when it comes time to resell the property, the lender is going to get a deeply discounted price, and not recoup the outstanding loan balance and other costs.

In the commercial market, there are three main sources of debt financing: banks, life insurance companies and commercial mortgage-backed securities. For multifamily properties there is a fourth, the government-sponsored enterprises.

For certain types of properties there is also financing through government programs, whether it is the Federal Housing Administration, Small Business Administration or U.S. Department of Agriculture.

But for those three main lenders, each has different attributes they are looking for, but Hartman added that generally they are lending at lower advance rates.

The good news is that interest rates are low, with the average commercial loan at 5% to 5.5%, he said. Back in 2008, it was in the area of 8%.

However, back in the boom period, even though borrowers were overleveraged and rates higher, commercial properties had fewer vacancies and thus were generating the cash flow to cover their debt.

Given the loss of jobs in the recession and resulting vacancies, properties are generating lower debt service coverage.

On the other hand, the multifamily sector, because of the shift of Americans to renting rather than owning, it is doing much better than the other types of commercial properties, Hartman said. Location can also affect the ability to obtain financing.

The KBW report said the commercial market experienced a slowdown in the second half of last year, although it believes sales growth was a positive surprise. The analysts expect this year to be “a continued modest recovery.”

They expect increased capital investment by commercial real estate investors as investment opportunities and funding availability both improve.

In the third quarter of last year, KBW said “commercial mortgage debt outstanding declined 4.5% year-over-year and 1% quarter-over-quarter. We expect continued modest declines through 2012, primarily driven by writedowns.”

CMBS issuance last year totaled $32.7 billion, up from $11.6 billion in 2010 but below the $40 billion to $50 billion expected by most industry experts, the report states. This year should see continued rebuilding of CMBS as a source of debt financing.

Today’s commercial real estate market, Hartman concluded, has opportunities for anyone who has equity capital to deploy; to be able to buy properties, you are going to have to come up with a higher downpayment than in the boom years, but there are some great deals to be had.

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