The biggest topic of conversation in commercial real estate right now, besides interest rates, is the large volume of debt maturing in the next few years. A total of $2.2 trillion in commercial debt is coming due between 2024 and the end of 2027, according to the data company Trepp.
Almost half of all the commercial real estate debt matures in the next couple of years, and this is shaping up to be a major problem for the industry. Most of the office debt and much of the multifamily debt cannot be refinanced at current debt levels and interest rate levels.
It is always important for brokers to understand a borrower’s options when faced with how to handle these situations. Commercial brokers can help their clients understand the options available on what to do with maturing debt as well as assess some of the pros and cons of these choices.
Property options
There are only four options for an owner of a property with maturing debt. The first is the most obvious: pay off the loan. This often requires a significant capital infusion, however. The second option is to sell the property. This option is problematic because it may not be a good time to sell, or the owner may not be in a good position to negotiate.
The third option is to extend the maturity date. The “extend and pretend” option requires the lender to extend the loan and “pretend” that circumstances will improve for the borrower, and they will eventually be able to pay back the loan. The downside to this option is that it almost always requires a capital infusion at the time of the extension.
The fourth option is to turn over the keys to the lender. Giving back the asset may be a good option, especially if there is no equity in the property. The best thing commercial real estate brokers can do right now is to help owners of maturing loans understand the pros and cons of each of these options.
Lender dilemma
There are only two options for a lender or servicer dealing with maturing debt. The first is that they can agree to extend the existing loan. The last thing a lender or servicer wants to do is to extend the loan only to have the owner hand the property back to them in a few years in worse shape.
That is why all extensions require “new skin in the game” in the form of offering the lender more capital. The amount of capital and the application of the capital is negotiable. However, borrowers must understand that there will be new capital required for any extension.
The philosophy behind this move is that lenders have faith that the borrower’s circumstances will change, and the loan will be repaid. There are all kinds of descriptive terms for this option, ranging from the aforementioned extend and pretend to “delay and pray” and “kick the can down the road.” But the main point is that the lender must believe that the borrower can make good on the loan.
The other option for the lender is to take back the property via foreclosure. This decision is typically made by weighing which option is financially best for the lender. While the average lender does not want to take back properties, if that is the best option, they will do it.
There are creative structures that have been emerging in commercial circles that allow an owner to put new capital into an over-leveraged deal, which is a commercial property that has more debt than it can repay. The borrower would get a loan extension for a few years and have a way to pay the new investment back. Again, lenders and servicers do not want an over-leveraged property back. They prefer to have a good owner continue to own and manage the property through the next few critical years in the industry, but they will require a cash infusion. That is why these creative structures are emerging.
Unique opportunities
The choices for a potential investor or buyer concerning these maturing loans come down to only two options. The first is to buy the property or note off market, which refers to properties that are for sale, but are not marketed by brokers. The second is to buy the property or note on market, which means through a broker or a note auction format.
When a lender or servicer sells a note or property, they almost always do it via an on-market format. The reason for this is simple — they will be criticized less for the amount obtained than if they sold the property to a single buyer in a private agreement. One way to get access to these properties is by looking at the new listings and on-line auction bid sites. The most inefficient way to get access to these properties is by placing a call to a lender or servicer or making an unsolicited bid.
The best opportunities usually are off market. These deals are best achieved by working with the existing owner. They offer early access to the property, exclusivity, potentially lower prices and higher profits. Remember, once a property’s loans reach maturity, the owner can pay the loan off, with significant capital infusion; sell the property; extend the maturity date (if the lender agrees); or hand back the property.
When owners choose to pay the loan off or extend the maturity date, they often need access to preferred equity for the capital infusion, which means a broker will have to help them find an investor. When an owner chooses to turn over ownership of a property, there is a unique opportunity for a broker to find a buyer to step in and pay off the existing loan and take ownership of the property. Of course, when an owner chooses to sell, there is a ripe opportunity for brokers to position their clients to buy the property.
The current state of commercial real estate is creating tremendous opportunities for savvy brokers to help their clients make the right moves, whether it is buying or selling, extending or investing. So, it’s crucial you know your options.
