Chances to Get Favorable Office Refinancing Are Fleeting

It seems like every day there’s new research and numeric evidence that the office segment is in generally deep trouble. Things are moving toward likely longer modifications, CMBS defaults potentially hitting a tipping point, and potential overall disaster in refinancing.

The conclusions are driven by falling usage, unsustainable levels of vacancy, working-from-home and hybrid models imposed on corporations, tumbling property values, rising interest rates, unaffordable interest rate caps, and tightening lending standards.

Well, it’s another day and here’s another study, this one from S&P Global Ratings. The key takeaways include:

• As market values of office properties fall, smacked down by lower space demands and rising interest rates, the ability for borrowers to get “new and favorable financing for mature U.S. office-backed loans is waning.”
• A macro-level scenario analysis suggests that if overall market value dropped by 40% from initial valuation (and remember those are valuations when money was cheap and, in many cases, prices had been driven up), a third of the outstanding number of office-backed secured loans would be in trouble.
• Existing lenders probably won’t face “losses across the board,” there are assets that will change hands if borrowers and lenders can’t agree on loan modifications or extensions.

S&P Global Ratings “undertook a macro-level scenario analysis, using various financing parameters and imputed market values, on a sample comprising the 72 U.S. single-asset, single borrower (SASB) CMBS transactions it currently rates.”

The SASB selection is the same that Trepp recently made because the complexity of the analysis for multiple asset and multiple borrowers would be far harder to pull off and more than necessary to get at least some sense of current conditions.

“We examined the possible range of exposures from the struggling office sector (based on a uniformed set of market-derived assumptions used to input office property values in today’s uncertain environment) and lenders’ willingness to keep providing capital based on revisited leverage and coverage matrices,” the firm said. “The results show that the outstanding volume of secured debt would decline by one-third if overall market value declined by 40% from initial valuation. In other words, unsecured lenders and property (equity) owners would need to refinance about a third of the outstanding secured loan balance.” That could vary greatly, as B and C class buildings would likely need a lot of rehab and remodeling to reach a level that tenants are looking for.

The irony is that up until early 2022, according to S&P Global Ratings, office properties were treated as a safe haven as lodging and retail CMBS delinquency rates hit 20% and above because of the pandemic shutdowns, as people assumed everyone would head back to the office.

The firm added that given current conditions, value growth will be hard to achieve for some period, “given the lower demand from office users and the negative pricing effect from higher interest rates.” New capital might not want to touch the projects, which could mean more assets will change hands.