This is the fourth in a series of articles that examine the truth behind the negative headlines. The previous articles include “CRE Experts Say ‘Not so Fast’ to Doom-and-Gloom Office Headlines” and “Unraveling the Office ‘Doom Loop’.”
At face value, the numbers could be considered alarming. According to a recent report in CommercialEdge, the total office debt nationwide is $920 billion, with nearly $150 billion of mortgages set to mature by the end of 2024. Furthermore, more than $300 billion of mortgages are slated to come due by the end of 2026.
It’s no secret that the office sector has struggled in leasing, valuation and debt maturities. But “office” encompasses everything from the older suburban Class B building to the Class AA trophy asset in the urban core. Because of this, experts tell Connect CRE that while office loans are set to mature, not all buildings are necessarily in trouble.
The Not-So-Great News
The experts acknowledged that debt maturities are an office-sector issue. Nor do the experts sugarcoat the issue. For some owners, those maturities could be very serious.
“Properties are unable to meet LTV (loan-to-value) and DCR (debt-coverage ratio) requirements and require large cash infusions from sponsors,” said Tower Capital’s Adam Finkel. Finkel added that large office properties in Los Angeles and New York have already returned to lenders while “there have been some Class A office properties trading at steep discounts,” he remarked.
Furthermore, “90% of office buildings have debt maturing in the next five years,” noted Adam Showalter with Stream Realty Partners, adding that many of those buildings’ current values are well below the debt owed. Showalter explained that given the Federal Reserve rate, 10-year Treasuries and the general market view on office, this valuation could change within five years. However, “a large majority of office owners and lenders will run out of time, given loan maturities before that event takes place,” he commented.
At one time, refinancing was once a solution to maturing debt. But not these days, which is adding to the problem. “As loans are coming due, the increase in rates is going to be shocking to some landlords who may have secured a note at 4% but are now facing over 8% as the note expires,” Aarica Mims with KDC commented.
CREXI’s Eli Randel agreed, adding that increased capital costs and decreased values make refinancing difficult. Still, “properties with term left on their loan can wait and hope for conditions to change, or otherwise work with their lenders on creative solutions,” he said.
But Not All Bad
But the current scenario isn’t impacting all office buildings. “Those properties acquired five to seven years ago by prudent borrowers who have opportunities to extend their loans by one to two years should get through this downturn okay,” observed Citadel Partners’ Scott Morse. The landlords and owners with expiring notes within the next 18 to 24 months, “with underperforming or under-amenitized properties” will be experiencing problems,” he pointed out.
Furthermore, “office properties that don’t have debt maturity issues are typically those that have strong fundamentals, such as low vacancy rates and long-term tenants with strong credit,” said Petra Durnin with Raise Commercial Real Estate. She added that office properties that are part of highly-amenitized and mixed-use purposes generate good cash flows from various sources.
But what about building owners struggling with cash flow? Again, it depends. Some owners might hand their keys back to the lenders. But as will be made clear in a follow-up article, this scenario might not be as prevalent as it might seem.
Or there could be opportunistic buyers on hand to help.
“The current debt scenario is a reset in asset values,” Durnin pointed out. “There is a very meaningful volume of dry powder waiting on the sidelines for this reset. Buyers able to participate in acquisitions, without being subject to the interest rate environment, will find incredible value in core assets in core markets.”
The takeaway is that debt maturities are one more thing the office sector struggles with. But not all properties are under the gun, suggesting that analysis is more a case-by-case scenario. Debt maturities can be viewed as impacting the entire market only “if lenders brush the entire category with the same brush,” MDL Group’s Hayim Mizrachi commented. “But this is not all office properties.”