CMBS Loans Give Insight Into Ongoing CRE Credit Crunch: Green Street

The current CRE market seems to be a whiplash land as owners, operators, and investors get pulled to look at the state of the economy, then resulting interest rates and the implications for refis, over to rising expenses of operations, then back to the economy, starting another round.

But it’s all important, and Green Street’s Danny Ismail and Harsh Hemnani looked at a lot of CMBS data to “study a sizable group of loans with large maturities in the next few years with an emphasis on office, retail, lodging, multifamily and industrial properties.” Current credit conditions are difficult, with 10-year Treasury interest rates up 230 basis points since January 2022 and a conventional, 10-year secured commercial mortgage all-in rate up 300 basis points to about 6% over the last 18 months. The last time such levels were seen was during the global financial crisis.

Average U.S. commercial properties are down in value by 15% already and “Green Street’s analysis of the unlevered expected returns on real estate versus corporate bond yields suggests that real estate values could decline by another [approximately] 10 percentage points to be priced ‘fairly’ relative to bond yields based on historical relationships.”

Bank loans — worth about half of all financing to CRE — have seen growth flatten as the institutions worry about getting caught on falling value. There is also limited available data on them, so CMBS loans become important for better understanding of credit conditions. They are already showing problems with some high-profile defaults. Green Street analyzed more than 15,000 CMBS loans representing $375 billion in value across office, multifamily, retail, industrial, and hotels. About 45% are maturing between 2023 and 2025.

And they’re getting caught in conditions that will require lower loan-to-value ratios along with higher interest rates. Combined with double-digit drops in asset values, many owners will need to either add equity to refinance or sell off properties. Given that office, retail, and hotel sectors represent about 85% of the coming CMBS maturities, owners in these sectors have some tough sledding ahead.

According to the authors’ calculations, “Office and retail borrowers seeking to replace their CMBS loans may need to inject up to 25% and 30% additional equity, respectively.” Hotels have lost less value, but still would have to kick in 8% additional equity on a 55% LTV. That also assumes “REIT quality assets.” Properties of lower value will need even larger amounts of additional equity.

Also, about 30% of CMBS loans since 2012 have floating rate resets. “Assuming roughly half of these borrowers have interest rate swaps or caps in place, this suggests that 15% of CMBS loans outstanding are facing interest costs in excess of their rental yields, which is unsustainable over long periods of time.”

Sadly, it is now too late to effectively and cost-efficiently hedge against rate hikes. The current cost of a 3% SOFR cap for a year is 2% of the loan amount, a six-fold increase since June 2022. That $50 million property will require another $1 million for the rate cap.