A typical office loan originated today would cover only 65% of the outstanding balance, requiring fresh equity or original debt to close the 35% debt funding gap.
This is according to simulations performed by CBRE to estimate the potential sizes of debt funding gaps based on hypothetical values.
The office debt funding gap arises when changes in property value or lending conditions cause the debt available to refinance a property to be less than its outstanding mortgage balance, CBRE said.
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The simulation modeled an office property loan originated in 2019 at a 4% interest rate with $10 million in net operating income (NOI), a 5% cap rate, $200 million total value, 72% loan to value (LTV), a $144 million loan balance and a monthly payment of $480,000. The debt service coverage ratio (DSCR) was 1.74 and the debt yield was 6.94% in the simulation.
CBRE simulated 611,226 scenarios to estimate the size of the funding gap if a loan were to mature today under a variety of parameters, including decreasing or increasing NOI, declining LTV, increasing interest rates and cap rates and differing amortization. The simulation assumed a minimum DSCR of 1.25 and a minimum debt yield of 8%.
Under these scenarios, a new loan would be large enough to pay off the existing loan just 10% of the time. In nearly every scenario where this was true, NOI had to grow by at least 5%. CBRE said this is an unattainable growth rate for most office properties in recent years.
Of the 144 scenarios that involved no NOI growth and no debt funding gap, the simulations found that the minimum amortization level was 18%.
“Although many simulations are more extreme than what most office investors face today, the overall results paint a grim picture of the troubled state of capital structures, especially for properties financed in 2019 – arguably the worst year to have acquired an office asset,” said CBRE.
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Kristen Smithberg
Kristen Smithberg is a Colorado-based freelance writer who covers commercial real estate, insurance, benefits and retirement topics for BenefitsPRO and other industry publications.
