In an era marked by unprecedented challenges, the commercial real estate and mortgage industries are bracing for yet another formidable obstacle on the horizon. As much as $2.6 trillion in commercial mortgages are scheduled to mature over the next four years, presenting a challenge for loan originators and their clients. For context, more than $700 billion in loans matured last year, with the amount set to gradually decline to less than $300 billion by 2027, according to Mortgage Bankers Association data.
“The wall of maturities represents a critical crossroads for the commercial mortgage market, impacting both borrowers and originators.”
This impending wall of maturities has far-reaching implications that will disrupt the financial landscape. It will potentially lead to a shortage of financing options, an increase in defaults and a decline in commercial property prices. While this problem is serious, there are strategies that commercial mortgage brokers and borrowers can employ to mitigate the cash-flow and financing challenges that lie ahead.
Looming crisis
This phenomenon of maturing loans within a concentrated time frame arises for several reasons. Key factors include a surge of originations during the low interest rate environment of the early 2010s, a tendency among borrowers to lock in favorable rates with longer maturities, and the cyclical nature of the commercial real estate market.
As a result, these loans are now reaching maturity simultaneously, coinciding with a period of higher interest rates and economic uncertainty brought about by hawkish monetary policy. The wall of maturities represents a critical crossroads for the commercial mortgage market, impacting both borrowers and originators.
With so much market turbulence, looming defaults and few deals transacting, one of the most significant concerns is the valuation gap. Lenders are minimizing proceeds and prospective buyers are seeking discounts for asking prices.
There is little middle ground for borrowers to account for debt-service-coverage ratio stresses, leading to reduced loan-to-value ratios and a potential decline in commercial real estate prices. Morgan Stanley estimates that commercial property values could plummet by as much as 40% from their recent peak, which would have a cascading effect on the industry.
Lender reaction
It’s important to note that the impact of these maturities are likely to vary depending on the type of asset. For example, office properties are expected to be hit harder than industrial or multifamily properties.
Responding to the rising default risks, banks are setting aside substantial provisions for loan losses. This approach could make them more cautious about lending money in the future, creating tighter lending conditions. Even the government-sponsored enterprises, Fannie Mae and Freddie Mac, are likely to be impacted, which will further complicate the refinancing of loans.
In response to the increased risk of default, lenders may impose higher spreads on interest rates and become stricter with underwriting requirements. This will restrict leverage and make it more challenging for borrowers to meet the necessary criteria, potentially exacerbating the financing crunch.
For borrowers, current loans with impending maturities also raise concerns regarding stresses tied to increased escrow and cash-reserve costs. As financing becomes scarcer and more expensive, the strain on borrower cash flow and liquidity adds another layer of complexity to the situation.
Mitigate challenges
Mitigating the cash-flow and financing challenges posed by these impending maturities requires a multifaceted approach. Mortgage brokers should communicate openly with borrowers and offer advice to help them successfully navigate the financial risks while also reducing risk to the lender.
First, consider cash-flow management. Borrowers have begun deferring payments and distributions to investors and equity holders to preserve cash, making it easier to meet other financial obligations. Additionally, selling noncore assets (such as vacant properties or underperforming assets) can help raise necessary funds.
Next is asset optimization. To enhance the value of their properties, borrowers must continually evaluate benchmark data for their respective markets. Making capital improvements to properties can increase their values and make them more attractive to potential lenders. Offering competitive rents, strategic marketing and exceptional customer service can further fortify a property’s position in the market.
The third is debt optimization. The dramatic shift in interest rates calls for a fresh approach to debt optimization. Instead of maximizing loan amounts at low rates, borrowers must focus on minimizing new infusions of equity and limiting capital calls to investors. With today’s higher-for-longer rate environment, as well as general uncertainty for both the short and long term of the yield curve, being proactive is essential as continued rate volatility will keep borrowers on their toes.
Running sensitivity analyses based on the forward curve can help borrowers assess their options effectively. If feasible, borrowers should consider fixed-rate loans with shorter terms or cash infusions to buy down interest rates. If permissible, they can seek to extend terms with their existing lender. The latter approach should be tailored to the loan type and lender, with borrowers presenting a compelling case to justify the extension.
Take action
The key to navigating the situation is proactive planning and preparation. Borrowers and brokers should start taking action now to prepare for the impending challenges. Here are a few steps they can take.
- Seek rescue capital. In some cases, borrowers may need to secure rescue capital or new equity investors. This infusion of funds can help address financial shortfalls and provide a lifeline to properties that face financing challenges.
- Plan and prepare. The impending wall of maturities will arrive swiftly, so planning and preparation are critical for borrowers and brokers. As lenders and servicers grapple with increasingly imminent extension and modification requests, maintaining open lines of communication and demonstrating consistent effort will be essential.
- Be realistic. It is crucial to have a realistic outlook on the future of an asset and the owner’s sources of funds. Loan extensions, discounted payoffs and principal paydown options may not be readily available without a well-thought-out plan.
- Stay informed. With attractive loan options limited, mortgage originators should keep clients informed about terms and rates. Defeasance consultants and third-party specialists in debt markets, hedging and interest rate derivatives can help clients create individualized strategies that take their personal circumstances and risk tolerance into account.
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These oncoming maturities are a critical challenge facing commercial mortgage originators and their clients. The potential consequences, from a drop in commercial property prices to a reduction in lending options, are severe and should not be taken lightly. But with proactive planning and the adoption of effective strategies, mortgage brokers can help borrowers mitigate the risks and emerge from this challenging period with their financial stability intact. ●
