Despite some improvements in liquidity, the commercial real estate debt market is contending with the dual impacts of a wave of maturities, exceeding the current capacity of the market, and severe price declines.

The result is an onslaught of maturing debt that is underwater. These mortgages are putting pressure on the market, though it is not entirely clear if this will translate into a new chapter of defaults.

The mortgage landscape has contended with a rising tide of maturities at the same time it has experienced a severe contraction in credit availability. We estimate that $1.7 trillion in commercial mortgages (including multifamily paper and construction and land loans) will mature between 2010 and 2014, an average of nearly $350 billion per year. According to our estimates, maturities will peak at nearly $370 billion in 2013. Maturing amounts will decline thereafter but will remain elevated for some time, exceeding $250 billion annually through 2017.

The wave of loans coming due, dubbed a tsunami by some, is the result of rapid expansion during the early to mid-2000s. The commercial mortgage market more than doubled between 2000 and 2007, adding approximately $1.8 trillion in net new debt. 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 $346 billion of net growth in one year.

Net flows to the commercial mortgage market turned negative after the collapse of Lehman Brothers and the global seizure in credit markets in late 2008. An estimated $200 billion was removed from debt environment during 2009 and year-to-date 2010.

The mortgage situation comes at a time when commercial real estate suffers from depressed property values. According to Moody's CPPI, values have fallen by 45% from their peaks in 2007. The result is that $900 billion of the $1.7 trillion in maturities through 2014 are currently troubled.

A relatively small proportion of this paper was set to mature in 2009 and 2010, a fact that probably helps explain the smaller-than-expected volume of distress so far in this cycle. But a rising proportion of maturities in 2011 and beyond are currently in some form of trouble. If property values show only negligible appreciation over the next several years, a rising number of coming years' maturities will be underwater.

There are, however, some positive indicators. First, there is increased liquidity. Major commercial banks and insurers are back with an appetite for larger, high-quality assets. And CMBS issuance is starting to come back, with approximately $10 billion of issuance so far in 2010. Second, deleveraging is being achieved in some cases through increased equity contributions and mortgage paydowns. And third, low interest rates have helped to reduce debt service payments. By our estimates, commercial-mortgage yields have fallen by as much as 300 basis points, and construction-loan yields have fallen by 500 to 600 basis points in 2010 as compared with 2007.The $900 billion of struggling mortgages maturing in the next five years will almost certainly add to the volume of delinquent and defaulted debt, currently estimated at $230 billion, though it will probably not all translate into distress. Increased liquidity and low interest rates will enable some borrowers to hang on and hope for better market fundamentals. Furthermore, currently depressed prices could increase, which would relieve some of the pressure. By our estimates, a 10% increase in property values would reduce the proportion of underwater maturities from 52% to 36%, and a 20% increase in values would reduce the proportion of underwater maturities to 16% .

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