Half of Commercial Mortgages Fail to Refinance

Half of Commercial Mortgages Fail to Refinance

The commercial real estate (CRE) market peaked in 2007, and has since been in a prolonged process of collapse. This is true for asset valuations across property types (residential apartments, office, industrial, self storage, health care, etc.), as evidenced by rising capitalization (cap) rates across the board.

Cap rates are to real estate what P/E ratios are to stocks; they measure the value investors are willing to attribute to each dollar of net operating cash flow generated from the property. In other words, cap rates can be computed by dividing the net operating income (NOI) by the value, or amount that an investor paid for a property.

Rising cap rates means that investors are demanding higher risk premiums on their commercial real estate investments. The going rate for high quality CRE is about 7 percentage points above the 10-year Treasury bond, or equivalent maturity “risk-free rate.”

In a continuation of the CRE saga, Bank of America announced that over half of commercial mortgages have been unable to refinance as notes reach maturity.

Nearly $1.24 trillion of commercial mortgages need to be refinanced over the next four years. With so much debt outstanding and in need of refinancing, the BofA announcement makes a bad situation worse.

Between 50 percent and 60 percent of loans on skyscrapers, hotels, shopping malls and apartment complexes failed to refinance within a few months of their maturity date this year, Bank of America Merrill Lynch analysts said in a report.

As a comparison what went on during the boom years, we should note that a record of $251.1 billion in bonds tied to commercial mortgages were issued in 2007 compared to $1.7 billion issued so far in 2010.

Commercial real estate firms are increasingly desperate. According to Thomson Reuters there are at least 12 CRE firms planning to sell equity in IPOs over the next year. Given that equity sales earlier this year have either completely failed to materialize, or have been executed at deep discounts, it is not likely that CRE firms will be able to re-capitalize properties that have decreasingly profitable operating margins.

Without a big government bailout, the 41 percent CRE decline since 2007 might just be the start of something much worse.