A looming Commercial Real Estate Financing Crisis presents challenges for building owners, but opportunities for commercial property buyers. In contrast to most residential mortgage loans, the majority of commercial real estate loans require bank review every three to ten years. At this review stage, banks can deny a commercial loan refinancing.
A recent survey by Deutsche Bank estimates that up to $1.3 Trillion of commercial real estate loans are coming due before the end of 2013. Deutsche Bank estimates that at least 50% of the individual commercial loans and up to 66% of those loans packaged and sold as securities will not qualify for refinancing!
What factors will cause these commercial loans to not qualify for refinancing?
Several key factors are at work. At one level, increasing commercial vacancy rates and falling lease rates will decrease the cash flows available to service mortgage debt. This decreased rental income stream will lower the Net Operating Income or “NOI” for commercial properties. The NOI is a key metric used by banks, appraisers and investors to value commercial properties. When NOI decreases, a commercial building’s value falls.
In addition, in general the “Cap Rates” used by banks, assessors and investors to value commercial buildings are rising. Cap Rates, as used in commercial real estate, are a measure of the ratio between a commercial properties annual income (NOI) and its purchase price. When financing was readily available, Cap Rates dropped significantly. With credit now more limited, Cap Rates have risen back to historical norms. Cap Rates have a significant impact upon a building’s value and its value for loan refinancing purposes – as Cap Rates rise, building values fall.
As a general rule, banks are tightening their lending standards and decreasing the allowable “Loan to Value” ratios – meaning that the banks want more cash equity invested into individual projects. Banks utilize loan to value ratios to determine the amount they will loan on a commercial property. When these Loan to Value ratios drop – as caused by drops in the NOI (lowering a building’s value) or increases in the Cap Rates used to appraise a property (again lowering a building’s value) – it effectively lowers the amount of money a bank will loan on a property. If a building’s value drops below a bank’s thresholds, the bank may require the building owner to inject significant additional equity into the project to secure the refinancing. Not all owners are capable of injecting this additional capital!
What does this mean to Tenants and Buyers?
- More commercial properties will be taken back by banks under foreclosure,
- Significantly more distressed asset sales as building owners look to unload their properties,
- Commercial buildings going back to bank ownership may present problems for commercial tenants, who should plan accordingly when negotiating new leases or lease renewals, and
- Distressed assets sales of commercial properties may present very attractive purchase opportunities for firms, government entities or even non-profits that may have the opportunity to purchase commercial properties at highly discounted prices – prices often far below replacement cost.
Contact Guidance to discuss how best to position your company – and protect it – for a purchase, lease renewal or relocation!
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Guidance Corporate Realty Advisors provides corporate tenant / buyer representation services to corporate real estate users in the Denver metropolitan area including Boulder, Colorado. Guidance also provides these services in all major U. S. markets, as well as markets in Canada, Asia, South and Central America, and Europe.
