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Commercial Real Estate Update
The Other Shoe Is Dropping: Where we are and how we got there.
The Dynamic
Commercial developers and many buyers finance their purchases with interest-only loans for fairly short periods, three to 10 years, to be paid off with a balloon payment at the end. The traditional exits are to sell or borrow again. The sales door is as good as shut. The few buyers out there want bargains.
The question then becomes who will refinance the billions in commercial real estate loans maturing nationally in the next three years. Values have fallen so far that refinancing is problematic at best. Consider an office building bought at the peak for $25 million and financed with a $20-million loan, for an 80% loan-to-value ratio. If it’s now worth only $20 million, the owner’s equity is gone. A lender isn’t likely to refinance the full $20 million debt since it would amount to loaning 100% of the property’s value. The owner, down $5 million already, isn’t going to be eager to put in more equity.
Notice that the issue isn’t occupancy. “A lot of these projects that could be challenged by this are very successful projects — 90% occupied,” says Moss of CB Richard Ellis.
 “Most of us are not going to pay off the balance of the loans when they mature. We’ll have to see when the deal comes to maturity whether it makes sense to extend or sit down and talk about a restructuring.” — Seth Werner |
Seth Werner, CEO of Hollywood-based Cypress Creek Capital, for example, says his portfolio, assembled for $400 million, has an average leverage of 70%. Now lenders want to lend only 50% and want guarantees. “Most of us are not going to pay off the balance of the loans when they mature,” Werner says. “We’ll have to see when the deal comes to maturity whether it makes sense to extend or sit down and talk about a restructuring.”
The Solution
The solution thus far has been for borrowers and lenders to agree on short extensions that have been described as “extend-and-pretend” and “kick the can down the road.” In the early 1990s, as commercial real estate values fell, lenders took over many failed projects and discounted rent or sold the failed projects to buyers who discounted rent — all of which only forced down the value of viable competing properties.
To avoid that cascade of falling values, says John Carey, managing partner at Whitehall Realty Partners in Jacksonville, “The feds have got to instruct the banks to be flexible.” Otherwise, “market values will plummet.”
In August, the Obama administration extended a bailout program to help the sector. Duane Stiller, president of commercial real estate owner and researcher Woolbright Development in Boca Raton, says lenders are only delaying the inevitable. Banks will have no choice but to clean up their books, breaking the impasse between buyers and sellers over values. Job growth — which usually lags in a recovery anyway — will at first just fill now-empty desks, not create enough demand to drive rental rates high enough to justify the levels of the 2007 peak and ease the refinance crisis. Industry insiders say it will be at least a year until the bottom is reached and a few years to sort out the wreckage. “It’s like after a hurricane — we’ve got a big mess to clean up,” Stiller says.
