CMBS office loans could be tougher to pay off on time as supply grows
Payoffs of maturing office loans in securitizations may be delayed more often in the next few years if increasing inventory constrains occupancy and rent growth, according to a new Morningstar report.
More than $170 million in maturing commercial mortgage-backed securities with loans due between 2020 and 2023 could be affected.
"Our concerns include the large volume of new supply that will continue to weigh on occupancy and rent growth as well as large office tenants frequently opting not to renew their leases and relocating to a more competitive property," Steve Jellinek, a vice president at Morningstar, said in the report he authored.
A higher level of leverage for offices than most other property types adds to the difficulty that borrowers would be able to obtain the funds needed to pay off their loans on time.
Office properties have a higher percentage of loans with LTVs over 80% than any property type other than retail. They also have a higher percentage of loans with debt yields below 9% than any property type other than multifamily.
But multifamily mortgages, even with poor metrics for probable loan refinance proceeds and debt yield — which are skewed by cooperative properties in the sample — should have little problem paying off on time because of the high percentage of properties under an 80% LTV. Loan refinance proceeds are estimated using underwriting of a 5% interest rate and a debt service coverage ratio of 1.35 times cash flow.
And unlike during the prior maturity wave, when overleveraged retail loans were a major concern, maturing retail loans should have the second-best payoff rate because lenders have shifted toward lower-leveraged, higher-quality properties and retail sales remain healthy, Jellinek said.
The highest payoff rate will be from industrial loans, where demand for warehouses and flex spaces is outpacing the supply and rent growth.
For all the CMBS coming due in the four years between 2020 and 2023, Morningstar anticipates an annual payoff rate in the range between 80% and 85%. The projection was made based on debt yields, loan refinance proceeds and loan-to-value ratios as benchmarks.
In comparison, the 2015 to 2017 maturity window had $222.48 billion in mortgages mature; the payoff rate declined each of those three years to a low of 72.3% in 2017.
By 2018, when $10.13 billion of CMBS —many of which were written post-crisis — came due, the payoff rate rebounded to 84.3%.
"The loans maturing in 2020-23 are almost exclusively post-crisis and generate less concern than precrisis loans because of lower leverage, and the underlying assets have generally benefited from rising property valuations throughout the loan term, bolstering the borrower's equity and easing refinancing concerns," Jellinek said.
He is more concerned about the $65 billion of loans expected to mature in 2023 as they have weaker metrics that those coming due the prior three years.
Over 83% of loans due in 2023 will generate enough cash flow to be able to refinance with proceeds sufficient to extinguish the existing debt. For loans maturing in 2022, the percentage rises to 86.2%.
There will likely be little difficulty finding lenders willing to refinance loans.
"Maturing loans have benefited from a growing appetite among other traditional lending sources such as commercial banks, life insurance companies and pension funds, as well as nontraditional debt funds and mezzanine lenders with less stringent underwriting requirements, many of which took out overleveraged loans that came due during 2016-17," Jellinek said.