Subject Matter Expert: Constantine Korologos, CRE
Kicking the can on commercial real estate loan maturities
The real estate industry isn’t making much of a dent in clearing its mountain of looming debt maturities. According to Trepp, nearly $1.8 trillion in commercial real estate loans are set to mature before the end of 2026.
Lenders are doing their best to postpone maturing debt with extensions and modifications. Many of the loans that were set to mature in 2023 were extended into 2024 and beyond, and loans maturing in 2024 are being extended out to 2025. The hope is that conditions will shift to relieve some of the pressure on liquidity, whether it’s lower interest rates, fresh equity capital, or improving NOI performance.
At some point, the ability to push maturities out is going to hit a wall. If, or more likely, when it does, lenders are going to be facing a higher volume of loans that will be more challenging to clear. The banks hold a significant proportion of that debt and have limited flexibility in what they can do about it because of regulatory oversight. Banks are not going to be able to continue to extend loans without sufficient capital reserves behind it.
Climbing out of a deep hole
Subsequent to the half point rate cut in September, baseline forecasts from economists are for the federal funds rate to decline from a 23-year high of 5.25–5.50% to settle at 3.5 to 4.0% by the end of 2025. While that can change with shifts in economic conditions and government policy (remember, we have an election in November), there is no indication that rates will approach the recent lows of the last four years. Either way, it is still significantly higher for those borrowers who were buying property at sub-4% cap rates and putting debt on property when rates were approaching zero. Borrowers with near-term maturities are looking at new debt service payments that, for many, could be as much as 75% to even 100% higher than their prior loan.
Debt cost “on steroids” also pushed values up, which makes it more difficult to refinance as values reset at lower levels. Even if interest rates do come down as presently forecast, it may not be enough for those borrowers facing maturity balances that are too high to refinance. The outcome is likely to result in a shake-out among weaker operators and those owners that are not well capitalized.
How “Noisy” will resolution be?
Borrowers and lenders alike are looking to buy more time with extensions. If the loan maturities can be unwound slowly, it creates an opportunity for the market to catch up so that less has to be worked out. How those maturities are resolved has the potential to create a domino effect on values.
If the building across the street has debt that’s maturing and they can’t refinance it, the note may be sold at a discount to a new owner who has a much lower basis, and that changes the competitive landscape. They could reduce rents and pull tenants away from neighboring buildings, which may result in further distress and loan defaults; distress could fuel more distress.
Is this wave of loan maturities going to push distress to levels such that the impact results in more bank failures, or can it be unwound methodically with less of a noisy impact? There is no clear answer to that yet. The market is still watching to see how things unfold. Certainly, there is a lot of opportunistic “dry powder” capital that has been raised, waiting on the sidelines to jump on assets and notes at an appropriately priced, risk-adjusted level. Ultimately, it is not so much the staggering volume of maturities that is concerning as it is how those maturities are managed and what kind of “collateral damage” occurs as those loans clear the system.
