Local Commercial Real Estate Foreclosures Tick Up In 2023

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This year, South Florida saw an increase in the number of significant business foreclosure cases filed.

Seventeen foreclosure lawsuits totaling at least $2 million on commercial real estate were filed for the 12-month period ending on October 30 and are still pending, according to the Business Journal. A year earlier, there were 15 lawsuits of this type at the same time.

The Business Journal reported in 2023 on four commercial foreclosure lawsuits that have since been settled out of court.

Rising building costs and high borrowing rates are posing problems for many developers, making it more difficult to sell their properties or refinance. Eight of the seventeen cases on the list are related to large-scale construction or remodeling projects.

Only one foreclosure involved an office that was leased to tenants, despite worries about the state of the office market across the country. But there were three cases concerning lodging establishments.

 

Source:  SFBJ

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Is A Sale-Leaseback Strategy A Viable Alternative For Your Business?

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By Ron Osborne, Managing Director, Sperry Commercial Global Affiliates | RJ Realty

 

As a financing method, a sale-leaseback holds more advantages for businesses compared to leveraging their balance sheets. With today’s escalated interest rates, a scenario has emerged where the sale-leaseback option outweighs borrowing avenues for companies. If a business’s borrowing rate for a leaseback (or cap rate) is significantly lower than its corporate borrowing rate, redirecting equity tied up in a building becomes a viable alternative, particularly for business expansion.

Often, businesses encounter opportunities to broaden their reach or enhance their current facilities. Capitalizing on these prospects sometimes demands more funds than readily available. In such cases, selling the property, unlocking the tied-up equity, and reinvesting it into business expansion or improvements becomes a more cost-effective solution than traditional borrowing options.

Consider this: if the borrowing rate stands at 9% to 10%, but the business can sell and lease back the property at 6% to 7%, there exists a substantial 200 to 300 basis point spread. Undoubtedly, this presents a far more advantageous financing route than leveraging the balance sheet.

This strategy empowers the company to retain control over the asset by becoming a tenant for a specified duration—a 5-year, 10-year, 15-year term, or as outlined in the agreement.  Sometime the buyer will give the ownership the First Right of Refusal or Option to buy back the property at some future time and price.

Sale-leasebacks have served companies, regardless of their size, for numerous years, facilitating business expansion, debt reduction, or other alternative uses made possible by the equity in their properties. They’re  an excellent method for companies to unlock dormant equity and channel it toward paying off debts, acting as a debt substitute, or funding crucial business-related upgrades.

Given the recent substantial rise in interest rates over the past couple of years, businesses eyeing property purchases or refinancing endeavors to expand could view a sale-leaseback as a viable alternative to an SBA loan.

 

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Distressed CRE Reaches Ten-Year High

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Distress has been the buzzy question making the rounds of commercial real estate for more than a year now. When will it really start? When will the falling prices finally bring in the large mounds of capital that have been waiting on the sidelines?

When will the gift wrapping get shredded? The boxes surrounding presents of cheap properties ripped open? The prices turning into big profits when interest rates eventually fall and values finally climbing back up?

GlobeSt.com has previously reported that a secret round of distress might be behind a lot of CRE market performance. MSCI released its U.S. distress tracker and it’s helping to put some surface on the bare bones of distress.

“The balance of distress in the U.S. commercial real estate market climbed for a fifth consecutive quarter to total $79.7b at the end of September,” they wrote. “This figure, which includes both financially troubled and bank owned assets, has not swelled to such a level since 2013, when the fallout from the Global Financial Crisis was working its way through property markets. Still, the current distress level remains less than half that reached during the height of the GFC.”

The actual outstanding distress through the third quarter of 2023 has reached $79.7 billion, though not evenly distributed by property type. As anyone in the industry might guess, the largest single source of distress right now is office, at about $32.5 billion, or almost 40.8% of the total. Retail is in the number two spot: $21.2 billion, or 26.6% of the total. Then comes hotel, 17.9% of all the distress at about $14.3 billion.

The bottom three categories are apartment/multifamily ($7.5 billion, 9.4%), other that includes sectors like self-storage and manufactured housing ($2.5 billion, 3.1%), and industrial ($1.7 billion, 2.1%).

However, the real concern for investors, developers, and owners should be what might come. “Potential distress is indicative of financial stress that, if not reconciled, has the potential to become full-blown financial trouble,” MSCI wrote. But the biggest danger isn’t office but multifamily, at $65.7 billion, or 30.4% of the $215.7 billion total.

But the possible exposure of office is still enormous, at $50.3 billion or 23.3%. Hotel’s $31.1 billion/14.4% comes next, after which are retail ($30.7 billion, 14.2%), industrial ($26.7 billion, 12.4%), and other ($11.3 billion, 5.2%).

“The composition of ownership for distressed assets shows that one-third of the balance of distress is tied to assets owned by private capital, while another third is associated with institutional investors,” they wrote. “Rather than by value, which skews towards institutional ownership, a look at the ownership composition by the number of assets indicates that private investors own 50% of the assets currently classified as distressed.”

 

Source:  GlobeSt.

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Commercial Real Estate Valuations Are So Hard-Hit That CBRE Warns Could Fall ‘Another 10%,’ After Saying Earlier They ‘May Come Down 15%, 20%’

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Workers will likely spend 20% to 25% less time in the office than before the pandemic, according to the head of real estate brokerage CBRE Group.

Chief Executive Officer Bob Sulentic said companies such as CBRE are seeking to balance in-person work with the recognition that people don’t want to spend hours in traffic.

The rise in remote work since the pandemic has had far-reaching implications for the real estate industry, including property owners that Sulentic’s company counts as clients. Office landlords have been confronting declining tenant demand as more companies adopted remote-work policies. That’s pushed the office vacancy rate in the US up to 18.4% in the third quarter, according to CBRE.

Landlords have also been pressured by the rise in borrowing costs, which has contributed to a nearly 21% decline in office prices in the 12 months through October, according to real estate analytics firm Green Street. Investors including Brookfield Asset Management Ltd. have defaulted on debt and walked away from buildings.

Sulentic said higher borrowing costs have dented commercial real estate valuations more than his firm originally forecast.

“We thought values may come down 15%, 20%. We now think that may be another 10%,” Sulentic said.

He noted price declines were “most acute” for office buildings.

 

Source:  Fortune

 

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CRE Transactions Expected to Fall 5% Next Year Amid Rising Treasury Yields

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To understand where interest rates might go, watching the actions of the Federal Reserve is important, of course, but so is monitoring yields of Treasury instruments. Whether bonds, notes, or bills, depending on the term, they have great sway.

Treasurys are considered safe investments, and so are one of those practical baselines for calculating risk adjusted returns. As the yields rise, so do interest rates.

But as is true with anything, trying to track every movement can become confusing.

For example, CBRE noted on Thursday, November 3 that the “recent bond market sell off has lifted the 10-year Treasury yield to nearly 5% and further dampened investor sentiment for commercial real estate.”

 

“Rather than inflation, a mix of short- and medium-term economic and political pressures is driving up bond yields,” they continued. “These include a stronger-than-expected economy with robust consumer spending, increasing term premiums, the surging government deficit and reductions in the Fed’s balance sheet (quantitative tightening).”

Based on such data and their analysis, CBRE said that it lowered growth expectations for CRE investment rate volumes in 2024. The projection had been +15%; now they are -5%.

“Our econometric models indicate that the rise in the 10-year Treasury yield to 5% or more, if sustained, will raise cap rates and lower capital values for commercial real estate,” they wrote.

And if they were correct that the 10-year would continue a strong upward pace, maybe the impact of higher interest rates would have such an impact. They might even be correct.

But this is where following short-term data flows can drive people to potentially make mistakes.

On Wednesday November 1, the 10-year dropped from the previous day’s 4.88% yield to 4.77%. Then on Thursday, it hit to 4.67%, and Friday closed out at 4.57%. Similarly, the 2-year yield went from 5.07% on Tuesday to 4.83% on Friday.

Econometric models can be wrong. Then again, they could be correct, look further out, and maybe yields will rebound in the long run.

But then, CBRE wrote that other than office, the “relative health” of CRE property types “makes forward internal rates of return (IRRs) increasingly attractive.”

“If the economy manages a soft landing and long-term bond rates ease, investment activity may surprise on the upside,” they wrote.

This is why solid hedging strategies make a great deal of sense.

 

Source:  GlobeSt.

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The Odds Are Stacked Against Maturities Refinancing

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Almost any problem can be solved if there’s a realistic plan and the necessary materials are at hand. But miss what you need for the repair and there’s only so far that you can go. That’s a problem facing commercial real estate right now.

There is an “historic volume of mortgage maturities,” as a recent Trepp analysis of Federal Reserve Flow of Funds data showed: $2.78 trillion in commercial loans coming due by 2027.

But will there be enough money to keep the bulk out of trouble? Up until Wednesday, the 10-year yields were moving tentatively toward 5% and have been at levels not seen since 2007. The higher Treasury yields go, the harder it is to argue for riskier investments without a lot of extra return. Shorter-term Treasury yields are even higher.

Even with a slight retreat of the 10-year yield with the Fed’s hold on interest rates and Treasury slowing expansion of planned new bond issuance, there is still abundant safety at respectable returns that becomes difficult to compete with. CRE property valuations have plummeted, with the Fed saying that after the reductions they were still elevated beyond where they should be.

Too many of the maturing loans were granted under easy money conditions and bigger amounts of leverage than are typically available at the present. Deals that need refinancing often make no financial sense because of the amount of capital needed to get new financing is prohibitive.

That is why the news on reduced funding for CRE is worrisome. Third quarter private real estate fundraising of $18.2 billion plummeted by 71% compared to the $63.4 billion of Q2, according to Preqin dataquoted by Bloomberg. Global property transactions fell from $31.9 billion in the second quarter to $26.9 billion in the third.

As the Wall Street Journal noted, CRE lending is at “historically low levels.”

“There is liquidity available,” James Muhlfeld, managing director at Eastdil Secured, told the Journal. “But it’s likely going to be more expensive, with lower leverage and with a different lender.”

All this raises the question of which projects will be able to afford refinancing — and if they can’t, who will be left holding the bag for the mortgages on those properties.

 

Source:  GlobeSt.

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A Sale-Leaseback Conundrum: Elevated Valuations Could Mean Later Problems

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The Federal Reserve’s October 2023 Financial Stability Report was not the sort of reading for CRE professionals to quell their fevered concerns about the industry’s immediate future.

As the Fed wrote, “Valuation pressures arise when asset prices are high relative to economic fundamentals or historical norms.” An apt description for commercial real estate. And elevated valuation pressures can “increase the possibility of outsized drops in asset prices.”

The implications might apply to any CRE property, but on reflection, sale-leaseback transactions seem like they might be particularly prone to adverse effects under the current conditions. The problem that appears for both buyer and seller is the potential longevity of the arrangement. Getting caught by an erroneous valuation is bad enough in the short term. Over a longer period, the effect can be magnified, with more to regret over an arrangement that will run years and possibly decades.

Under a sale-leaseback, the initial owner of a property is also the occupant. That owner decides to sell the property to an investor that will become the new owner and landlord.

The initial owner wants to use the property, often over a long period of time because that party prefers to keep control for years at least or perhaps decades. So, as part of the deal, that party agrees to remain a tenant, often on a net lease basis.

It’s a common type of arrangement. The first owner wants the sale to free capital locked in the building that might be put to better use, like R&D, acquiring another business, or expanding into a new sales territory.

In normal times, understanding the true value of the property is fairly straightforward. But currently, that isn’t possible because there is a lack of price discovery. If, as the Fed suggests, properties are overvalued, then the seller might seem to get a premium, assuming that an experienced buyer won’t recognize the danger, which a bit of a stretch.

However, say the transaction happens on that valuation. The buyer will need rents going forward that justified the price it paid, and they would need to be higher than true market rents. Overly high valuation likely means higher taxes that are paid by the seller. It could be that taxes would eventually come down, but it would require the local government to reassess the property.

This doesn’t mean that a sale-leaseback with net lease can’t make sense, but it might require more thought and negotiation for changing conditions.

 

Source:  GlobeSt.

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The Fed Says CRE Valuations Are Still Elevated

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The Federal Reserve’s October 2023 Financial Stability Report reads like a slightly early major Halloween trick for commercial real estate — no treat in the pages. Overly high asset valuations, even after all that’s happened so far, and ongoing high interest rates are flashing warning signs for the central bank.

One aspect is of particular concern to CRE professionals.

First, the overall view, based on a periodic survey the Federal Reserve Bank of New York conducts, the most recent having taken place from August 10 to October 4. Here is the top line:

“The two most frequently cited topics in this survey — the risk of persistent inflationary pressures leading to a more restrictive monetary policy stance and the potential for large losses on commercial real estate and residential real estate — were mentioned by three-fourths of all survey participants, up from one-half of all participants in the previous survey.”

The grim views are all focused on real estate, whether commercial or residential. For a bit of moderation, the survey was of 25 people, “including professionals at broker-dealers, investment funds, research and advisory fi rms, and academics,” the Fed wrote.

Far from a representative sample, but given the expertise, concerning. About 70% of the experts pointed to commercial and residential real estate as among the biggest risks over the next 12 to 18 months. The only other factors gaining that type of attention were a pairing of persistent inflation and monetary tightening. Auspicious company.

The big problem for CRE is valuation. As the Fed wrote, “Valuation pressures arise when asset prices are high relative to economic fundamentals or historical norms.” An apt description for commercial real estate. And elevated valuation pressures can “increase the possibility of outsized drops in asset prices.”

What is an apparent puzzlement in the Fed’s report is that even as prices have continued to decline, real estate valuations have remained elevated.

“Aggregate CRE prices measured in inflation-adjusted terms continued declining through August,” the report said. “Capitalization rates at the time of property purchase, which measure the annual income of commercial properties relative to their prices, have increased modestly from recent historically low levels but have not increased as much as real Treasury yields, suggesting that prices remain high relative to rental income.”

Office sector prices are particularly elevated, “where fundamentals are especially weak for offices in central business districts, with vacancy rates increasing further and rent growth declining since the May report.” But that doesn’t leave other sectors free and clear.

Some part, maybe significant, of this may be the ongoing lack of price discovery. With transactions down and many sellers holding off, waiting for improved pricing, while a lot of buyers look for bargains in distress, it’s hard to tell how much properties should be worth. CRE has the possibility of seeing significant additional drops in valuation, which would then cause even more problems with refinancing.

 

Source:  GlobeSt.

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CRE Loan Delinquencies Post Four Consecutive Quarter Of Increases

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Delinquency rates for mortgages backed by commercial and multifamily properties increased during the third quarter of 2023, according to the Mortgage Bankers Association’s (MBA) latest commercial real estate finance (CREF) Loan Performance Survey. The delinquency rate for loans backed by commercial properties has now increased for four consecutive quarters.

At. 5.1%, “the delinquency rate for loans backed by office properties now exceeds those of loans backed by retail and hotel properties, while the delinquency rates for multifamily and industrial property loans remain below 1%,” said Jamie Woodwell, MBA’s head of commercial real estate research. 

He continued, “Commercial property markets are working through challenges stemming from uncertainty about some properties’ fundamentals, a lack of transparency into where current property values are, and higher and volatile interest rates. The result has been a slow and steady uptick in delinquency rates, concentrated among loans facing more of those challenges.” 

 

Source:  Connect CRE

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Should You Sell Your Commercial Property Before Your Loan Matures?

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By Ron Osborne, Managing Director

Sperry Commercial Global Affilates | RJ Realty

 

The decision of whether or not to sell a commercial property before a low-interest rate loan matures and needs to be refinanced at a higher interest rate is a complex financial decision that depends on various factors.

Here are some considerations to keep in mind:

  • Current Market Conditions: Assess the current real estate market conditions in your area. If property values are high, it might be a good time to sell and take advantage of the equity you’ve built.

 

  • Equity and Profitability: Consider how much equity you have in the property and whether selling would result in a profit or capital gain. If you can make a significant profit, it might be a good time to sell.

 

  • Loan Terms: Review the terms of your existing loan, especially any prepayment penalties or fees associated with paying off the loan early. Factor these costs into your decision.

 

  • Future Interest Rates: While you expect to refinance at a higher interest rate in the future, it’s essential to consider the potential interest rate increase and its impact on your cash flow. Consult with a financial advisor or mortgage expert to understand the implications.

 

  • Cash Flow and Expenses: Evaluate your current cash flow and property expenses (Property Insurance is at an all time High and increasing). A higher interest rate will increase your mortgage payments, potentially affecting your property’s profitability.

 

  • Tax Implications: Consult with a tax advisor to understand the tax implications of selling the property, especially regarding capital gains taxes.

 

  • Alternative Investments: Explore other investment opportunities that might provide a better return on your investment compared to the potential future interest rate increase on your property loan. Consider a 1031 exchange with a high-quality single tenant that can afford the expenses.

 

  • Risk Tolerance: Assess your risk tolerance and financial stability. If you are risk-averse or concerned about potential cash flow issues with a higher interest rate, selling might be a safer option.

 

  • Market Predictions: Consider economic and market forecasts. If there is a strong consensus that interest rates will continue to rise significantly in the near future, it may influence your decision.

Ultimately, the decision to sell a commercial property or refinance before a low-interest rate loan matures depends on your specific financial situation (can you add equity that will be required to lower the loan amount to the lenders requirements), investment goals, and market conditions. It’s advisable to consult with financial advisors, real estate professionals, and mortgage experts to make an informed decision based on your unique circumstances.

 

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