The pandemic has hit commercial properties hard – especially restaurants, retailers and hotels, which are having a hard time making mortgage payments because of reduced business.
The office building at 580 Westlake Park was purchased with a $91 million loan that was packaged into a commercial mortgage-backed security. The property has entered foreclosure, due to high vacancy rates. Its problems preceded the pandemic and the resulting economic crisis, but as cash-strapped commercial tenants are missing lease payments and their landlords are missing mortgage payments, experts fear more properties will follow its path in upcoming months.
As a result, the industry is facing a “wave of foreclosures” over the next several quarters, according to securities data company Trepp, which warned that “borrowers may be strategically defaulting on their loans.”
Borrowers with loans coming due in 2021 or before have stopped making payments at a rate six times greater than those whose loans are due later, according to Trepp (a 1.66 percent delinquency rate compared to 0.27 percent, respectively). That suggests such borrowers, believing they will not be able to find financing to keep their buildings when their current loan expires, are cutting their losses by defaulting sooner, rather than later. Stopping payments can also put pressure on a lender to negotiate with the borrower, said Matt Anderson, managing director at Trepp.
While data suggest owners of smaller properties are more directly impacted by the recession — loans with balances of less than $1 million have a delinquency rate twice that of the overall portfolio — larger property owners appear to be most aggressively cutting their losses.
The term of a commercial real estate loan generally comes due before it is fully paid off. When the loan expires, or becomes mature, borrowers generally take out a new loan to pay off the first – a practice that allows both sides the flexibility to reset the terms to better reflect market conditions and the borrower’s financial state.
For some mortgages maturing amid a pandemic recession, that’s a problem. Commercial rents become harder to pay when fewer people eat out, shop in brick-and-mortar stores or travel, and some landlords have seen revenues evaporate. Trepp has found signs that borrowers with large loans about to mature do not believe they will be able to secure an extension or refinance.
Loans of more than $25 million comprise 36 percent of real estate debt maturing by the end of 2021. They also account for 57 percent of the delinquent balance. In stark contrast, no bank loans in that price range maturing after 2021, by which point the market is expected to recover, is delinquent, according to Trepp data.
Lodging and retail have been hardest hit, according to a survey by the Mortgage Bankers Association survey. Roughly a quarter of loans backing lodging properties, such as hotels, are delinquent, although the figure is improving slightly — 23.4 percent of loan balances were delinquent in August, compared to 26.2 in July.
Delinquencies on mortgages for retail properties, on the other hand, are edging higher – 15 percent of loan balances were delinquent in August, compared to 14 percent in July. Retail properties, which include both stores and restaurants, continue to flounder under social distancing regulations. A survey of Texas restaurants conducted by the National Restaurant Association suggested the situation may soon get worse — 50 percent of operators said it is unlikely their restaurant will still be in business six months from now, absent government relief.
Not all loan portfolios have been impacted equally. Trepp data show the overall delinquency rate for commercial loans held by banks was 0.59 percent, while the commercial loans banks bundled into securities and sold to investors are faring much worse. Roughly 13 percent of those securities were delinquent in August, up from 12 percent in July, according to the Mortgage Bankers Association.
“The commercial mortgage-backed securities (CMBS) market, which has the greatest reliance on hotel and retail loans, has seen delinquency rates rise to record highs,” said Jamie Woodwell, vice president of commercial real estate research for the Mortgage Bankers Association, in a statement.
Jeff Davis, managing director of Mercer Capital in Nashville, Tenn., said there are commercial real estate borrowers who are now “underwater” – the value of their properties has dipped below the loan amounts.
It’s unclear how many are in that position, but the situation is more likely with loans that have been bundled into securities, because such loans often cover a higher percentage of the building’s initial value.
Debt holders are incentivized to work with borrowers, rather than foreclosing on their properties, because of the difficulty marketing a building during an economic slowdown, Davis said. Nonetheless, with the number of commercial mortgages that are delinquent, foreclosures are on the horizon, and will likely damage the bottom lines of banks and those that have invested in riskier CMBS bonds.
“No one has had to face the music yet,” Davis said. “We don’t know how loud the music’s going to be.”
One thing he does know? “It’s a good time to be a buyer.”