OAKLAND, CA-At a time when credit is very tight the commercial real estate market faces rising demand for mortgage financing, setting the stage for a likely financing shortfall, according to Foresight Analytics, a locally based provider of national real estate analysis and projections.
If the shortfall does materialize, it will lead to increased distress in the commercial real estate debt market and further downward pressure on values, which is what Foresight is predicting. Regardless, Foresight principal Matthew Anderson expects the commercial real estate debt market to show minimal net growth during the next decade because “the high volume of loans maturing in the multifamily and commercial mortgage markets will absorb most of the origination volume for several years.”
Specifically, Foresight estimates that $814 billion in commercial and multifamily mortgages will mature during 2009 to 2011. Commercial mortgages, at $594 billion, will comprise the bulk of the maturities in this period. Multifamily mortgages of approximately $220 billion will mature during the next three years.
During 2009 alone, Foresight estimates that nearly $250 billion in combined commercial and multifamily mortgages will mature, representing an all-time high for the market thus far. In addition, Anderson estimates that combined commercial and multifamily mortgage maturities will climb to approximately $300 billion per year during 2011 to 2013. Maturing amounts will decline thereafter, but will remain elevated for some time, exceeding $200 billion annually through 2017.
Looking backward, the combined commercial and multifamily mortgage market more than doubled between 2000 and 2007, adding approximately $1.8 trillion in net new debt, according to Foresight. The most rapid growth occurred in 2005, 2006 and 2007, with more than $300 billion of net growth in each year. The peak growth was reached in 2007, with $379 billion of net growth.
Since the collapse of CMBS issuance in 2007 net flows to the commercial mortgage market have been constrained. After net inflows of $60 to $80 billion per quarter during most of 2006 and 2007, net flows have shrunk to an average of $14 billion during the third and fourth quarters of 2008, according to Foresight.
“Banks and Thrifts have become the primary source of net growth in the market,” Anderson states. “The resilience of this sector is impressive, especially in light of the other pressures weighing on banks’ balance sheets and appetite for new lending.”
Even so, net volume is down, he says, averaging $21 billion per quarter during the second half of 2008, as compared to $33 billion per quarter during 2006 and 2007. With a lack of new activity, CMBS loans have been contracting, both as a result of paid-off loans being removed from the CMBS pool and as a result of default and foreclosure activity.
“The contrast to the boom years of 2006 and 2007 could not be more stark: whereas CMBS loans accounted for 41% of net inflows to the commercial mortgage market during 2006 and 2007, they are now accounting for net outflows from the market,” Anderson says.
Life companies have remained net contributors to growth in the market, accounting for $1.7 billion per quarter or 12% of the net growth during the second half of 2008. While the share is up from the 2006 and 2007 period, the dollar volume is down by about 50%.
Looking again at maturities, Foresight finds that approximately one-half of the mortgages maturing during 2009 to 2011 were originated during 2004 to 2008. The two largest components will come from the 2004 and 2005 origination years, with an estimated $127 billion in maturities for both of these cohorts during 2009 to 2011. While not the peak years, both of these years were characterized by robust investment activity, and financing shortfalls in the new lending environment could emerge.
“We estimate significant refinancing demand from the 2006 and 2007 ‘boom years’ cohorts during the next several years,” Anderson says “We are particularly concerned about the ability of these properties to qualify for refinancing, in an environment with lower valuations and lower loan-to-value ratios.”
During 2009 and 2010, Foresight estimates maturities of $17 billion and $34 billion, respectively, for these origination year cohorts. “Many loans made during the boom years were underwritten on higher values and higher loan-to-value ratios than available in the market today,” states the report. “As these loans mature, we expect to see particular distress among these origination year vintages.”
Rather than underwriting new loans on the one hand, or demanding full repayment on the other, Foresight says many portfolio lenders are granting temporary one-year extensions on maturing mortgages. While this relieves the pressure on 2009 originations, it clearly is adding to the volume that will be back in the market for financing in 2010.
“We are particularly concerned about the ‘boom year’ vintages coming due in the next few years,” Anderson writes. “Perhaps even more than 2009 or 2010, our focus is on the wave of boom year vintages maturing in 2011, setting that year up as a likely pivotal year for the mortgage market. If values have rebounded sufficiently by then, the market could avoid wide-spread defaults. But if the market is still depressed, a significant amount of these maturities could go into default.
If values and cash flows stay depressed beyond 2010, Foresight estimates a much larger $300 billion of maturing loans from these two vintages will be at risk in 2011 to 2013.
An alternative scenario is possible, though. If the market is able to deal with these maturities over the next several years, a wave of defaults and foreclosures could be averted, Anderson says.
“In this scenario, we would expect the inventory of maturing loans to ‘crowd out’ demand for net new lending,” he says. “We have already seen the beginnings of this during 2008.”
With rising maturities and slowing net mortgage market growth during 2008, Foresight estimates that refinancing of maturing mortgages comprised about 80% of total originations in 2008, as compared with an average of approximately 35% during the 2000 to 2007 period.”
The overall result is likely to be a protracted period of modest real–inflation-adjusted–terms. The combined multifamily and commercial mortgage markets grew by 9.4% annually in real terms from 2000 to 2008, ahead of the 7.4% annual growth during the 1980s boom and nearly as high as the 10% to 11% growth rate during the 1950s and 1960s.
“We expect the next decade to more closely resemble the 1990s, which only grew by 0.8% annually in real terms,” Anderson says.