Five years after the start of an unprecedented housing market decline and four years since the collapse of Bear Stearns, Lehman and the credit markets, the commercial real estate debt markets only sluggishly arose from their extended state of suspended animation. Like many in the industry, we anticipated a slower-than-normal recovery—the depths of the recent recession, staggering numbers of problem loans, the compromised state of the recovery and unfortunate political gridlock, have hamstrung any rebound. But the extent of delay has been surprising. Without a prod from government regulators, banks and other lenders have continued to resolve problem loans at a turtle's pace, avoiding precipitous shocks to their balance sheets. As a result, the opportunity to invest in distressed assets has been limited.
Finally some momentum may be building for banks to sell off more assets at significant discounts. Although the majority of outstanding mortgage loans are not delinquent, many mortgages are under-secured, because of property value declines and increases in commercial mortgage credit spreads. Except in primary 24-hour gateway markets and the buoyant multifamily sector, asset cash flows have been compromised by seemingly chronic tepid tenant demand for many commercial properties—office, retail, and industrial. Even current loans with property values equal to or more than loan balances may find refinancing challenges at maturity as a result of more conservative loan-to-value and coverage requirements.
After peaking in 2010, bank net charge-offs remain well-above pre-crisis levels. Lenders have been selectively liquidating loans to raise capital and strengthen balance sheets, cautiously managing any losses against current earnings. This carefully controlled approach may have curtailed any surfeit loans in the secondary market to date, but the drawn-out economic comeback marked by persistent high unemployment and restrained leasing activity suggests it is only a matter of time before secondary market transactions intensify.
The current environment also inevitably leads to more financing opportunities and recapitalizations involving quality assets whose borrowers need capital infusions to hold onto properties. Recapitalizations can take the form of subordinate or mezzanine debt and preferred equity. One way or another, increasing numbers of these transactions will occur with more than $1.73 trillion in bank, nonbank and thrift commercial real estate debt scheduled to mature between now and 2016, according to Trepp. Another source of potential investments will likely be various CMBS special servicers who also hold large volumes of maturing loans. Some servicers may be less prepared to cope with possible widespread defaults and will eagerly liquidate or seek to recapitalize loans before credit events occur.
Against this backdrop of growing distressed asset dispositions and recapitalizations, ongoing dislocation among lenders since the credit market collapse continues to limit the availability of real estate debt financing. As a result, excellent opportunities should continue to surface at an accelerated pace in the subordinated loan/mezzanine debt tranches of the capital stack. In return for accepting some greater risk than senior debt, investors may anticipate achieving higher returns with greater protections than equity investors. Despite Europe's problems and other obvious obstacles slowing the pace of dramatic economic improvement, the sluggish real estate recovery in the US and the pressure of time finally will take hold.
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