Academic journal article Journal of Real Estate Portfolio Management

Commercial Real Estate Debt Maturities: Shortfall & Implications

Academic journal article Journal of Real Estate Portfolio Management

Commercial Real Estate Debt Maturities: Shortfall & Implications

Article excerpt

Executive Summary.

Global capital markets in 2008 experienced historic illiquidity, with nearly every major country's central banking system having to infuse capital directly into their member banks. These dramatic steps were taken to help keep banks solvent while they continued to absorb massive losses related to business, insurance, and real estate debt. This paper estimates the size of the commercial real estate debt financing needed in 2009 and beyond. The paper also seeks to further expand and update evolving investment possibilities, given the status of the capital markets in the United States in 2009 and the increasing and unprecedented high demand and low supply of debt available for the financing and refinancing of commercial real estate properties. By looking at the ten-year historic trends of existing commercial debt demand and supply, a forecast of future debt demand and supply shortfall through 2018 is developed. Then the potential impact on commercial mortgage pricing is discussed.

Commercial Mortgage-Backed Securities

Created in 1988, the Commercial MortgageBacked Securities (CMBS) investment vehicle grew from issuances of $10 billion annually in 1988 to over $255 billion in 2007. According to a Goldman Sachs report ("GSR") released in October 2008, CMBS issuance accounted for approximately 42% of the commercial real estate (CRE) loans issued from 2005 through 2007. 1 While over $535 billion in CMBS debt was issued from 2005 to 2007, only $12.1 billion was issued in 2008. Nearly $1.135 trillion of CMBS has been issued since 1999 (Exhibit 1), and an estimated $200-$220 billion in real estate CMBS debt should mature during 2009 to 2011. The total amount of CMBS debt projected to mature over the next ten years is approximately $800 to $900 billion.

Loans collateralizing CMBS pools can be either fixed rate or floating rate. As of January 2009, Deutsche Bank analysts found that CMBS floating rate loans were having significantly more problems with refinancing than fixed rate loans. This phenomenon may be because floating rate loans are more likely to have shorter terms and less amortization than fixed rate loans. Conversely, many floating rate loans have loan extension provisions so they may be less vulnerable to refinance risk, assuming that the loan is performing. However, the extension provisions do not preclude floating rate loans from technical defaults based on under- lying CRE mortgage loan covenants, such as loan- to-value (LTV), debt service coverage (DSC), and other required coverage ratios. Technical viola- tions are very likely a key contributor to refinanc- ing issues.2 Another risk in the CMBS loan product is the significant amount of five-year interest-only "conduit" loans maturing during 2010 to 2012 (Ex- hibit 2). These conduit loans were originated in the high leverage environment of 2005-2007 and are at risk of not being refinanced, as lower debt to equity ratios and asset price deterioration combine to lower debt availability. An estimated $60 billion of these "interest-only" loans mature from 2009 to 2012, with little availability of refinancing in a dysfunctional market.

The MBS marketplace (both residential and commercial) collapsed in 2008 when the public markets lost confidence in origination underwriting, rating agencies, and the long-term performance of real estate as a whole. Many investment banks were caught with commercial loans on their books that had not been securitized and most investment banks converted to regulated commercial banks in order to access federal TARP or TALF funding. The public market fears that credit rating agencies did not properly rate CMBS debt securities and began to question the Triple-A ("AAA") rating in 2008 but were even more afraid of B-rated bonds. In the commercial real estate securities market, emotional investor panic played a large role in this pricing dislocation, as the severe re-pricing of CMBS bonds has been out of line with these securities' underlying collateral performance. …

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