Lenders Seek Refreshed Valuations on Legacy Loans

Commercial real estate has become a forced march accomplished on tiptoe. Borrowers facing loan maturities and an inability to refinance at higher rates talk to lenders. Often the result is an extend-and-pretend agreement.

Loans get modified or extended so the lenders don’t have to write down the asset that would mean a loss and possibly a sign that other loans they hold might also be worth far less than the paperwork says. Lenders don’t lose the property and also don’t have to suddenly come up with large amounts of capital to refinance. Banks with between $100 billion and $700 billion in assets had the highest median for loan modifications, according to Moody’s.

Extend-and-pretend has a dark side, says the Federal Reserve Bank of New York. A new analysis from them suggests that attempts to plaster over problems and wait for a favorable rate change don’t help. Instead, it leads to increased financial pressure on banks.

It may be that patience is coming to an end. Altus Group said that debt funds and other CRE lenders have started to focus on reviewing and updating valuations.

The values of outstanding loans depend on what the properties are worth that back them. Every loan starts with a property valuation. So long it remains either equal to the original amount or higher — there is no underlying risk from the potential of maintaining a loan worth more than the property.

But prices and valuations have been sharply falling for a couple of years. To assume that a CRE property is necessarily worth what it was in 2021 or 2022 is unrealistic. Some properties are and some have increased in value. But all? Not possible.

Office is an example. Valuations have been spiraling down outside of the 10% to 15% of the stock that is Class-A or Trophy.

The approach of “getting a sense from borrowers themselves on how properties are performing,” as Altus wrote, assumes that the borrowers are thorough in their analysis and forthcoming in their answers.

Lenders have been working with extend-and-pretend strategies who suddenly start considering revaluations to better understand their current situation, and risks already know there may be problems.

“This has been impacting portfolios for some time now and there is still room to go depending on vintage of particular loans and asset class,” Andrew Pabon, director of valuation advisory at Altus Group, said in prepared remarks.

Lenders are taking new approaches to manage risk while better understanding. Altus pointed to a note from Trepp about the $242 million 521 Fifth Avenue loan sent to special servicing in June for maturity default. The 39-story nearly 500,000-square-foot Class A office tower has a top tenant with nearly 5.2% of the space and a lease that ends in 2035. The property is 77% occupied and has a debt service coverage ratio of 0.79x. The lender is working on a dual-track approach with foreclosure proceedings while discussing an extension with the borrower.

It may be — especially in office but likely in other property types as well — that lenders are about to get far tougher because they’re coming to a point where they have to start dealing with the risks that have been hanging over them.