Investors in commercial real estate are torn between anxiety and anticipation regarding the recent repricing of assets. Those who feel optimistic are actively seeking out assets that are likely to default and can be acquired at lower prices. The key lies in analyzing the timing of loan maturities.
- Securing refinancing for commercial-property loans has become increasingly difficult due to rising interest rates and stricter lending conditions.
- Not all asset classes and markets will experience equal pressure, as there are variations in asset-price growth and loan-to-value ratios.
- By utilizing a broad estimation based on value growth and loan conditions, one can pinpoint specific market and asset-class combinations that may encounter greater challenges.
The decrease in prices over the past few quarters does not automatically imply that every property owner will default. For instance, if an investor had purchased an asset long before the surge in asset values during 2021 and 2022, the asset might still have experienced significant equity growth, making refinancing a viable option. By considering market prices and typical loan-to-value (LTV) ratios, one can make rough estimations of potential problem areas.
Examining combinations of markets and sectors is essential. Prior to the pandemic, the Manhattan office market was the largest and most liquid investment market in the United States, if not the world. However, in recent years, the Dallas apartment market surpassed Manhattan offices due to preferences for that property type and robust tenant demand in the area. Comparing these market and sector combinations can help identify where the most severe challenges may arise.
When analyzing asset prices using the RCA Hedonic Series, it becomes evident that both the Manhattan office and Dallas apartment market-sector combinations have experienced substantial price growth over the past 22 years. Manhattan offices displayed a modest compound average growth rate of 4.4% during this period, while Dallas apartments demonstrated a faster pace at 6.6%. However, with the rise in interest and mortgage rates since their pandemic lows, all asset prices face difficulties.
The graph illustrates the pricing trends for Manhattan office buildings and Dallas apartment buildings since 2001.
LTV ratios that lenders use are often influenced by interest rates, and as rates have increased, lenders have become less willing to provide credit due to uncertainties surrounding valuations. According to MSCI Real Capital Analytics Mortgage Debt Intelligence, in 2021, an average apartment borrower in Dallas could obtain a loan with a 64.4% LTV ratio. However, this figure has dropped to 59.0% so far in 2023. Assuming a borrower received an interest-only loan in 2013 and maximized the LTV, with Dallas apartments priced at USD 69,455 per unit, the initial mortgage amount would have been approximately USD 46,513. Taking into account the price growth between 2013 and 2023, the investor could refinance in 2023 without requiring additional equity.
The situation for Manhattan office properties is less favorable. An investor who purchased at USD 680 per square foot in 2013 has experienced a cumulative price gain of only 4.9% since the initial purchase. However, the achievable LTV has drastically decreased from 64.4% to 54.0% during this time. The amount that could have been financed in 2013, USD 438 per square foot, has now fallen to USD 391 in 2023. If the maximum loan is assumed, this investor would need to secure an extra USD 47 per square foot in new equity to refinance at current levels.
Investors who are concerned likely entered the Manhattan office market more recently. For example, an asset purchased in 2021 has already experienced a 15% decline in value. When combined with the lower LTVs available, the investor would need an additional USD 100 per square foot to make refinancing feasible. This amount represents approximately 14% of the asset’s value.
Merely considering these basic figures of prices and LTVs reveals that even if an investment has shown some growth in value, it can easily be overwhelmed by the changing financing circumstances. This analysis assumes, of course, that financing is available at a certain cost. Recent weeks have witnessed rapid shifts in conditions, and these benchmarks primarily reflect mortgages originated in the first quarter of 2023. Recent developments indicate that very few lenders are willing to assume the risk associated with the debt portion of the capital stack for office properties.
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It’s important to note that not every loan is destined to go bad. Once again, this analysis has relied on several simplifying assumptions to outline the problem. One could debate the suitability of using interest-only loans as an example, as well as the impact of loan amortization over its duration. Nevertheless, even a simplified scenario can assist investors in directing their attention to market and sector combinations that may encounter difficulties.