Borrowers and lenders are starting to grapple with the billions of dollars in commercial real estate loans made during the boom year of 2007 that are coming due this year, in a greatly contracted economy.
Experts have warned of a rash of recapitalizations, refinancings and building sales. In New York City alone, nearly $70 billion worth of commercial mortgages that were bundled together and issued as collateral for bonds are maturing this year. Of those, $26 billion, or 37.4 percent, are five-year loans that were originated during the height of the real estate bubble, when underwriting standards were loosest, according to data from the research firm Trepp LLC.
These include loans on prominent properties, including the Manhattan Mall, with $232 million maturing, and the Jumeirah Essex House, with a $180 million loan, according to Trepp.
“These loans are going to have the hardest time being refinanced since they were underwritten when property values and revenues were far higher,” said Thomas A. Fink, a managing director at Trepp. “We are going to see a wave of loans maturing this year, then again in 2014 and 2017, when the 7- and 10-year deals underwritten during the bubble mature.”
Most large commercial mortgage loans are typically not self-amortizing — that is, they require a balloon payment upon maturity.
While the number of loans maturing is expected to spike this year — $40.7 billion worth of securitized commercial mortgage loans matured last year and $49.5 billion worth is expected to mature in 2013 — the universe of lenders has shrunk. European banks, reeling from the debt crisis, have mostly stopped underwriting loans in the United States, while the market for commercial mortgage-backed securities remains relatively small, at roughly $30 billion in new issuance expected this year. And while insurance companies have increased their appetite for commercial mortgage loans, they are very conservative in their lending standards and selective in their deals.
“This means there may not be enough money available to refinance all of the debt that is coming due,” said Lawrence J. Longua, a clinical associate professor at the Schack Institute of Real Estate at New York University.
In a typical situation, a building that was worth $100 million in 2007 was financed with 80 percent debt, or $80 million. Now the loan — which was interest-only, meaning no principal was paid — is maturing. The borrower owes $80 million, but the value of the property has also dropped, to $80 million. This means that the ratio of the loan to the value of the property is 100 percent. Lenders have little appetite in this market environment for highly leveraged loans, so in one increasingly common outcome, the borrower will recapitalize the property by finding an equity partner to inject new capital into the deal, thereby lowering the overall amount of debt on the property.
Other possible resolutions include the lender extending the maturity date of the loan in the hopes that the property’s value will rise, or pursuing a foreclosure. It is also becoming more common for banks and other lenders to sell their loans to third-party investors who may negotiate with the borrower.
One factor that may drive more deal activity this year is that banks, special servicers and other lenders are eager to find solutions to troubled loans now, rather than postpone a resolution in the hope the market will improve down the road, said Scott Rechler, the chief executive and chairman of RXR Realty, which has recapitalized several properties in the last year, including the recent acquisition of 620 Avenue of the Americas.
“The first half of 2011 was very strong, with a lot of deal-making,” Mr. Rechler said, “but then several incidents, including the European debt crisis and the downgrading of the U.S. debt, made the market seem frothy. This was actually somewhat healthy because it put things back into perspective.”
As a result of these market jitters, he said, “lenders who had been waiting in the hopes that the market would improve, realized that things were still unstable and so they are more ready to resolve their loans now than in the past. Maybe not in the first quarter of this year, but by the second and third quarter I see a lot of things in the pipeline.”
Already, the number of recapitalizations has ballooned. There was $13.3 billion worth of recapitalizations nationwide in 2011, according to the research firm Real Capital Analytics, the most since the firm began tracking the number in 2001.
Another factor driving deal flow is the efforts by European banks to offload some of their American loan portfolios. In December, for example, Blackstone bought a $300 million portfolio of commercial loans backed by American properties from Eurohypo, the troubled real estate arm of Commerzbank in Germany. Other sellers include Allied Irish Banks, Bank of Ireland and Anglo Irish. American banks have also been shedding loans: In September, Bank of America sold nearly $1 billion worth of loans to several investors at a discount.
The sale of these loans can help spur deals because investors who buy these loans at a discount have more room to negotiate a payoff with the borrower, said Andrew A. Lance, a partner at the law firm Gibson, Dunn & Crutcher. A loan that has an outstanding balance of $100 million, for example, may sell to an investor for $80 million, enabling the investor to settle the loan with the borrower for any price between $80 million and $100 million, resulting in a profit for the investor and a discount for the borrower. While under this situation the original lender loses out, in the case of several European banks, regulators are ordering them to increase capital and shrink their balance sheets.
Dune Real Estate Partners participated in such a deal last year when it acquired the loan on the Mark Hotel on East 77th Street from Anglo Irish, recently completing a recapitalization of the property. Dan Neidich, the chief executive of Dune Real Estate Partners, said: “There are so many players now who aren’t the natural owners of real estate — like banks and special services — that never intended to own equity and who want to exit those positions. It opens opportunities for people like ourselves, who are in the business of taking equity risk, and bringing capital into the market to restructure deals.”
But not all borrowers will find themselves in trouble. There are many New York landlords who can simply pay down the loans without much struggle, market experts say. Vornado Realty Trust, for example, refinanced a $430 million loan at 350 Park Avenue in January with $300 million in debt and $132 million in cash. It is currently in the market to refinance the $232 million loan maturing on the Manhattan Mall, at Broadway and 33rd Street.
Still, even those borrowers who can pay down the loans themselves will have to contend with the softened market. “The key issue that cuts across all property types and all kinds of loans,” said Dennis W. Russo, a partner and co-chairman of the real estate practice at the law firm Herrick, Feinstein, “is that property values — the value of the collateral that secures the debt — are down. Combine that with the fact that lenders are conservative right now, and the bottom line is that in many scenarios, borrowers are going to have to find additional capital.”
Despite these jitters, commercial real estate sales rose sharply in 2011. Hui-yong Yu of Bloomberg reports, Commercial Property Sales Rose to More Than $220 Billion in U.S. Last Year:
Commercial property sales rose 57 percent to more than $220 billion U.S. last year, led by retail properties and garden apartments, Real Capital Analytics Inc. said in a report today.
More than 14,700 properties, each worth at least $2.5 million, changed hands in 2011, the New York-based real estate research firm said. Retail-property transactions rose 91 percent from a year earlier to $42.4 billion, and sales of low-rise apartments increased 70 percent to $34.5 billion. Manhattan accounted for 12 percent of total deal volume.
Sales rose as investors sought relatively higher yields from income-producing real estate and debt-laden owners unloaded properties acquired during the bubble years. Deals slowed in the second half of 2011 as turmoil in the market for commercial mortgage-backed securities curbed financing. Office and hotel transactions fell in the three months through December after six quarters of “large” year-over-year gains, Real Capital said.
“Buyers have started to broaden their horizons both geographically and by property type,” the firm said.
The biggest declines in capitalization rates were seen in well-leased, high-quality suburban offices and in shopping centers anchored by grocery stores, Real Capital said. Cap rates are calculated by dividing a property’s net operating income by purchase price, with rates dropping as prices rise.
Banker & Tradesman reports that Boston ranked 18th on a listing of the top 30 cities worldwide that attracted commercial real estate investment in 2010-2011, and are expected to continue leading the way over the next decade according to a recent report from Jones Land LaSalle (JLL). Even Northern Nevada’s embattled real estate and construction industry has hit bottom and is on the road to recovery (buy casino stocks like Las Vegas Sands).
In Canada, commercial real estate transactions in the Calgary region ballooned in 2011 with both dollar volumes and deal velocity significantly higher than the previous year. But you already know my thoughts on the Canadian housing bubble (commercial is less vulnerable because large public plans own most of the prime properties).
In Europe, Property Wire reports on strong demand for German commercial property:
Transaction volumes for Germany's commercial real estate market will exceed €20 billionin 2012 with continued strong demand from both somestic and foreign investors, it is claimed.
According to research by international real estate advisor Savills real estate worth €22.6 billion changed ownership in Germany in 2011, marking a 20% increase on 2010.
‘The final quarter of 2011 recorded the second best investment volume of the year at approximately €5.8 billion, showing little evidence in the investment market of a deteriorating macro economic environment,’ said Lars-Oliver Breuer, head of investment at Savills Germany.
‘Given a number of uncertainties it is difficult to provide an outlook to 2012 but what will be crucial is whether the situation in the financial markets stabilizes and if the eurozone succeeds in convincing investors of its stability,’ he explained.
‘Financing will be the predominant issue this year but if the continuously strong demand for German real estate can be translated into deals the 20 billion mark is realistic for 2012,’ he added.
Savills research shows that as in previous quarters the retail sector dominated German markets in the last quarter of 2011. Overall retail generated an investment volume of over €11 billion, making up almost half, 49%, of total transactions in 2011 and representing an increase of 60% on 2010.
The office sector, which has historically dominated the German investment market, accounted for just below 35% of all transactions in 2011. Overall offices accounted for €6.58 billion of the investment volume in 2011, up from €4.88 billion in 2010.
According to Matthias Pink, head of research at Savills Germany the reason for the increase in retail investment is partly due to the higher rental stability of retail properties. ‘Investors who continue to focus on secure investments appreciate this characteristic. Another reason is the stable and currently very good consumer sentiment in Germany,’ he said.
Overall almost half of Germany’s 2011 total transaction volume was invested in the leading five markets of Frankfurt, Berlin, Hamburg, Düsseldorf and Munich. Due to several large volume deals Frankfurt led the way generating a single asset transaction volume of over €2.3 billion, making up 14% of the total German transaction volume.
Munich also recorded a strong increase almost doubling its volume invested in single assets in 2011 to €1.6 billion. In Berlin volumes were up 11% and in Hamburg they were up 14%. But in Düsseldorf the transaction volume decreased by approximately 40% compared to 2010.
The share of foreign buyers was approximately one third in 2011 with investors of Anglo Saxon origin accounting for over half of all foreign investment. As in the first half of the year open ended and closed ended funds were among the strongest buyer groups and jointly invested €7.6 billion.
The second half of 2011 saw a notable increase in investment activity from insurance companies and pension funds as well as listed property companies and REITs.
Indeed, pension funds have been busy snapping up real estate in Germany and other European cities like London and Paris (click on image below):
As you can see, institutional investors aren't too anxious about maturing real estate loans. Private equity real estate funds like Blackstone and Lone Star will be scooping up distressed loans for a song and making a killing in the process for themselves and their limited partners.
Below, John Levy and FOX Business hosts Connell McShane and Jenna Lee discuss the current commercial real estate market.