The amount of commercial mortgage debt maturing is set to spike this year, when loans taken out during the height of the real estate bubble start coming due. Between 2015 and 2017, more than $300 billion will need to be refinanced.
That's more than 2.5 times the amount that matured from 2012 to 2014, according to Trepp.
This wall of maturities will be a real test of the recovery of the capital markets. Property values have rebounded in many parts of the country, particularly in so-called gateway cities, which are attracting foreign investment. Underwriting standards have also loosened amid growing competition from banks, insurance companies and conduit lenders, and interest rates are still low.
Yet rates are inevitably headed higher now that the Federal Reserve has ended its quantitative easing program, and vacancies are rising at office and retail properties, which account for the bulk of maturing loan balances.
New risk retention rules, which must be implemented by January 2017, could increase the cost of new loans.
CMBS issuance fell just short of $100 billion in 2014 and is forecast to rise marginally this year. The pace of originations will need to be stepped up considerably to take down the maturity wall. Even so, Trepp estimates that almost 20% of the commercial mortgages maturing over the next three years will require additional capital, either from current borrowers or new buyers, when the loan is refinanced or the property is sold.
"CMBS investors are well aware of the risks inherent in the wall of maturities," the data tracker wrote in a report published late last year. "The question is, what will the economy look like in six months, in a year, in two years when the brunt of this wave is set to hit the CRE market?"
To be sure, participants are much more optimistic about the ability of these borrowers to refinance than they were even a year ago. JPMorgan, for example, believes that 80% of the commercial mortgages maturing in 2015 will be refinanced; in 2013 the bank only expected 74% of those loans would be refinanced.
And Wells Fargo expects $105 billion of the $130 billion of commercial mortgage debt set to mature in 2015 alone to be securitized.
Rising Property Values
What's changed? For starters, property values have recovered significantly, although not uniformly. Prices of larger properties have risen substantially since the financial crisis, allowing many of these owners to easily refinance with loan-to-value ratios again at reasonable levels. However, prices for smaller properties have not appreciated at anywhere near the same rate as assets in the large cap CRE market, leaving them with high LTVs and therefore greater refinance rates.
"In aggregate, the larger loans in the top MSAs have appreciated back above where we were in 2007 they are not necessarily as underwater as some of the smaller loans in secondary markets," said Alex Cohen, chief executive of Liberty SBF, nonbank commercial mortgage lender.
Moody's/RCA CPPI Core Commercial Component Index has increased 12.8% year over year (as of September's data) and, as a result of double-digit annual returns over several years is only 5.8% below its previous cyclical peak in the fall of 2007.
In contrast, real estate research and consulting firm Boxwood Mean's composite Small Commercial Price Index, which covers 117 metros, has gained 5.9% year over year as of September (less than half the growth rate of CPPI) and is 13% below its peak.
"This pricing trend disparity explains why a greater proportion of small balance borrowers might still be 'underwater' or facing some refinancing challenges compared with borrowers with investment-grade property loans," said Randy Fuchs, principal at Boxwood Means.
The five biggest securitized loans maturing in the first quarter are all backed by properties in gateway cities: the $142.6 million Grand Plaza (held in JPMCC 2005-LDP5), the $100 million Park 80 West — A and B notes (LBUBS 2005-C2), the $88.9 million Century Centre Office (GSMS 2005-GG4), the $59 million SLS Beverly Hills (JPMCC 2013-FL3) and the $56.2 million 401 Fifth Avenue (GECMC 2005-C2), according to Fitch Ratings.
At the same time, CMBS underwriting has become increasingly aggressive as evidenced by the rising number of loans that pay only interest for part or all of their terms, and weakening recourse terms.
More than 40 CMBS loan origination programs have been set up in the past year, according to Moody's. The competition has resulted in looser lending requirements, making it easier to originate loans on terms that are within reach of borrowers who originally obtained financing before the credit crisis.
"Even though many of these loans have traditionally low debt yields, they are finding CMBS financing and are ending up back in newly issued deals," the ratings agency stated in a December report. "In a classic Catch-22 scenario, aggressive CMBS 2.0 loan origination will help ease the refinance tensions of many CMBS 1.0 loans."
New Crop of Lenders
There is even a crop of new CMBS lenders that just look at small loans — including those sized under $5 million. Liberty launched a CMBS Direct Lending Program in November. It targets loans as small as $1 million and as large as $30 million, on office, retail, industrial, multifamily and hotel properties. The lender recently underwrote a $7 million CMBS loan for an experienced hotel sponsor to acquire a Hilton Garden Inn hotel near Chicago. The deal closed in under two months.
Ray Potter, a founder and managing partner of R3 Funding, another small balance lender, said that lenders are targeting the small balance loan space because they can generate additional revenue and origination volume. "Outside of the gateway cities there has not been as robust lending from the banks and that is where CMBS originators are looking to increase their volume and profit; because you can get a higher profit margin on a $5 million than you can from a larger loans."
The wall of maturities may present an opportunity for originators, but it also presents a risk to mortgage bond holders. In 2012, a much smaller wall of maturities resulting from five-year loans taken out in 2007 sent the Trepp delinquency rate to its highest level of all time: 10.34%. Maturing volume that year was 40% of what it will be in both 2016 and 2017.
Of course, the shorter tenor of these loans meant that they did not benefit from as much of a recovery in property values or loosening in underwriting standards as will 10-year loans that come due this year and next.
The CMBS delinquency rate has since fallen, to 5.75% in December, its lowest level in five years.
Currently, multifamily properties have the highest rate of maturing delinquent or specially serviced loans at 12.4% and 12%, respectively. That's a potential concern, since multifamily is the third most heavily represented property type among balances maturing over the next three years. However, the high delinquency in 2016 multifamily maturities comes mainly from the $3 billion of loans backed by interests in New York's Peter Cooper Village/Stuyvesant Town.
The delinquency rate for office properties is at 6.08% and for retail properties, 5.66%, according to Trepp. These two properties account for 63% of the balance of maturing loans.
JPMorgan expects that loans structured with LTVs of less than 70% will be more easily refinanced than high levered loans coming due at the same time. But even mezzanine loans, with LTVs between 70% and 80%, can find funding.
Refinancing may be more difficult for loans maturing in 2016 and 2017, which were taken out at the very height of the real estate boom. JPMorgan expects that between 65% and 70% of these will be refinanced. The lower expected success rate is largely correlated to the higher debt loads on the underlying properties, which have LTVs of 80% to 100%.