Will Refinancing Become Easier This Year?

The question of refinancing commercial real estate properties in the coming year has become one of life’s great mysteries. At the opening of 2023, the assumptions were that inflation would be curtailed, transactions would renew, price discovery would happen again, and all would be fine with the world of CRE.

Everyone knows what happened then. Last year was beset with ongoing economic thrashing, high costs of refinancing, bank failures, worried banks tightening credit, even fewer transactions, and more concerns about what will happen. In the last few months, conditions seem to have turned favorable. Inflation has been falling – although this week’s numbers have given the market pause – the economy has still seen growth, and the jobs market is still keeping people working. On the other hand, the amount of CRE debt maturing this year has increased from $659 billion to $929 billion due to lenders granting extensions and modifications to loans over the past few years and Fed officials have made clear that interest rate cuts won’t happen before March.

Welcome to the one thing certain today – uncertainty. There’s no sitting back after good news, only monitoring everything all the time.

“If I knew where interest rates were going, I’d be a bond trader and not a working lawyer,” Eric Goldberg, partner and co-chair of the real estate department at law firm Olshan Frome Wolosky, tells GlobeSt.com.

Just as important to CRE financing as the Fed’s own benchmark federal funds rate is the 10-year because it forms the basis of many risk-adjusted investment calculations. If you could get nearly 5% on a bond, why take a chance on something else/? The rates did come down from those relative highs and at the time of writing seem hovering around 4%. But make a bet on that continuing? Difficult to argue the point when there are so many mixed views of the current landscape.

“The market does think rates are coming down,” Goldberg says. “Somehow the perception becomes reality. It’s what I’m also seeing in terms of mortgage financing in New York and around the country.” Money’s becoming more available. “I see it coming back for office buildings. That one I can’t say I’m basing it on actual metrics I’ve seen, but lenders are loath to take over office space. I’m expecting a strong first quarter and others are as well.” But even the more optimistic have learned from the recent past. “I’m expecting a strong first quarter and others are as well.”

Then there are the more skeptical. Fitch Ratings said that commercial real estate credit trends would continue to deteriorate through 2024 and into 2025. While office properties would lead the decline, retail, hotel, multifamily, and industrial would all face deterioration.

“I look at a whole bunch of indicators,” Brad Werner, construction and real estate leader at accounting and consulting firm Wipfli, tells GlobeSt.com. “You’ve never had a resell market as frozen as now. Good luck if you have an office you’re looking to refinance in 2024. There’s probably a death spiral for office in 2024 unless you had a smaller deal.”

Maybe death spiral is a little harsh for the category as a whole. There are challenges with hybrid office and predicting when, and if, employee occupancy will again work largely on company leased properties. Class-A and trophy office buildings will likely find a way forward unless the owner heavily leveraged on previously available near-zero interest rates. Otherwise, the lender might demand more additional equity than the owner has or is willing to commit. Class-B and -C face broader challenges, with lower net operating incomes and often outmoded facilities and features, all of which means higher refurbishment costs with less income.

Cushman & Wakefield in January did an analysis of U.S. markets, using data from MSCI Real Capital Analytics. They had said as of the third quarter of 2023 there was $79.6 billion in outstanding distressed properties. Of that, office was 41%; retail, 27%; hotel, 17%; multifamily, 9%; and industrial, 2%. Going into 2024, though, they say that the potential distress could be as much as $215.7 billion, or “larger than the cumulative distress observed during the entirety of the Great Recession.” That is a lot of disarray for markets to absorb while lenders decide whether it’s same to refinance properties.

There were some positives. As property values skyrocketed, so did rents. That appreciation insulated loan-to-value ratios. Implied LTVs for accumulated appreciation and outstanding loan balances for properties purchased between 2010 and 2019 was 51.5%. That is a sizeable cushion, but probably not for the properties owners bought with high leverage and low interest between 2020 and 2022.

“It really comes down to what your underwriting assumptions were,” Benjamin Jacobson, one of the two partners at Forman Capital, tells GlobeSt.com. “They’re not going back to where they were in 2019, 2020. I think we’re still going to have an issue because I don’t think anyone was underwriting an environment like this for refinancing their property.”

Even if rates did suddenly drop, Jacobson suggests caution. It’s not as though the last ten years of low interest was representative of the much broader U.S. economic and financial history. In the past, the Fed raised rates when growth was too high and dropped them when the danger of overheating passed. But it generally didn’t make changes because the markets would prefer cheaper money.

“Why are rates going to come down so quickly?” Jacobson asks “What is going to happen that will be so bad that will require that type of financial easing? It’s not going to be anything close to anywhere it was before. I keep hearing from a lot of people who see this wall of maturities next year. At a certain point everyone runs out of liquidity. The banks won’t be able to hold [the properties] either. Use an extreme example of office. At a certain point, the mortgage can’t be paid anymore for whatever reason. The banks want to get rid of the notes just for regulatory [reasons]. They can’t have so many non-performing loans on their book. I think a lot of this is wishful thinking that rates will come down.”

“In the short term, I think there’s going to be some pain in multifamily and continued pain in office,” says Werner. “I think hospitality and retail will be the sectors that won. They were beaten up in the past so they learned what not to do. There was a lot more emphasis on asset management. Making sure you have the right tenant mix, making sure you maximize those assets. Retail in particular has been really good. Optimizing performance of those assets.”

What has yet to hit, Werner thinks, is “when tenants decide ‘I’m not going to stomach any more price increases.’” If inflation continues to come down, the people sending the rent payments will want to know why prices increase at a faster rate. There is a lot of new multifamily inventory coming online this year, and the added supply will push down the prices. “When multifamily family apartments can’t refinance, I think that’s going to be a rude awakening. I think in spaces like multifamily that used to be safe like multifamily, there’s going to be pain that we haven’t seen in 20 years.”

So, when it comes to refinancing, it’s still likely too early to expect the best. Markets are still working themselves out and there’s too much uncertainty about what will happen. Whatever the situation, the stronger the building’s operation and more robust the NOI, the better chance you might have with a lender.