As seen in a few headlines over the past weeks, there have been some large national real estate investors that have defaulted on loans and rattled the commercial real estate markets. As we will discuss below, this may be the tip of the iceberg as investors are facing refinancing costs significantly higher than their current cost of debt in addition to the cost and difficulty in retaining their tenants.
Per an article posted by Fitch Ratings in November last year, there is nearly $26.5 billion, or 1,493 conduit and agency loans, within Fitch-rated multi-borrower transactions that are maturing by year end 2023. The combined weighted average coupon (“WAC”) of these loans is depicted in the table below:
These loan rates are significantly lower than what could be achieved in the market today, estimated to be in the 6.50% to 6.75% range dependent on property characteristics. Office properties make up a significant concentration of this near-term roll. According to a report performed by Trepp and Compstak, $40.47 billion across 353 loans secured by 583 office properties will mature by the end of 2024. Of additional concern, the report noted that across all of these properties, at least one of the top five largest tenants has a lease expiration within the next two years making a refinancing scenario that much more difficult.
Source: TREPP
Per the report, the most concerning subset of this data is the $6.25 billion of loans maturing by year end 2023. Given that these loans will have to refinance at the near peak of the Fed tightening cycle, they could see their respective interest costs increase by 40 to 60 percent.
While this in itself is a difficult refinance scenario, what makes this that much more difficult for office properties is the current leasing environment. There has been significant spread widening between starting and effective rents in order to sign and retain tenants in strong markets. Per the Trepp and Compstak report, the spread has increased 340 bps for Class A buildings and 270 bps for class B buildings since the third quarter of 2019.
The spread expansion of effective and starting rents is important because it indicates that landlords are likely having to spend more or provide more concessions to achieve the same starting rents. The difficulty with these rent spreads is exacerbated by tenants signing shorter-term transactions for less space with minimal rent growth, making new leases and renewals that much more expensive.
In conclusion, there are significant headwinds for the commercial lending market within the coming years. The office sector is facing stress that will likely take years to resolve. Cooperation between lenders and landlords will be required to clear this hurdle. There is a potential for loan defaults but there are many other financial disincentives for lenders to do so such as writing down the value of the loans, legal expenses from lengthy court cases, and transfer taxes.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Vice President, Acquisitions
Boyd Watterson Asset Management, LLC
