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You might know that Sound of Music sing-a-longs are a thing in live theater and online. You can bet that one of the favorites is Climb Every Mountain. If only triple net lease could step out of the spotlight.

Unfortunately, the sector seems to be providing encore performances as average closing cap rates keep their upward inclination, according to the Lomuto Report out of Northmarq.

“[The] indicators are saying we’re probably not done with rising cap rates just yet,” Chris Lomuto wrote. “Lots of existing inventory to burn off, maturing loans that may be difficult to roll over, developers needing to recycle capital, tight spreads, and a dearth of 1031 buyers. These are not traditionally a recipe for stable or falling cap rates.”

The mechanisms at work seem clear. In short, there’s more supply and less demand, squeezing out the value owners can claim and lowering the willingness of buyers to pay higher prices. As long as the conditions continue, there’s upward pressure on closing cap rates.

Though Lomuto notes some trends that could eventually head things off and restore a more dynamic market. For example, the average asking cap rate trend for all NNN started to rise in May 2022, when they were about 5.25%. With some minor ups and downs, it’s continued to rise and has gained roughly 100 basis points to 6.25%. Owners are recognizing that they can no longer expect as much as they could have in the near past when markets were at a high and the full impact of higher interest rates hadn’t yet been felt.

With the rise in asking cap rates had been compression of the gap between them and benchmark yields from, in the case of the federal funds rate, 587 basis points in January 2021 to 91 basis points in December 2023. The gap to the 10-year Treasury had been 488 basis points in that same January and now are 222. The S&P 500 earnings were spaced out by 295 and now that gap is 239. All in all, the biggest gap is within under 240 basis points.

Where things can get a little odd is looking at cap rates by product type. Lomuto shows a number of categories: auto and car wash, convenience and gas, dollar stores, grocery, industrial, office, pharmacy, and QSR. Measured from peak pricing, pharmacy is up by only 75 basis points (he points out that issues with Rite Aid and Walgreens should have had more effect). Grocery, one of the die-hard categories, has seen cap rates up over dollar stores. And office seems up only by 50 basis points — okay, more than odd, more like crazy.

When transactions are thinner than usual, “it’s very important to look critically at individual comps, including a thoughtful survey of what else is on the market now, when quoting a cap rate.”


Source:  GlobeSt.

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Even the experts appear reluctant to predict what 2024 holds for the commercial and multifamily mortgage markets, though they hope the year will bring more clarity.

The just-released Mortgage Bankers Association’s 2024 Commercial Real Estate Finance Outlook Survey describes an unsettled market for borrowing and lending – but anticipates conditions will stabilize in the new year.

One thing is clear. Even though borrowing has declined, the level of outstanding mortgage debt has continued to rise. “A decline in sales transaction and refinance volumes has meant less new debt being extended, but it also means that fewer loans are paying off than in many earlier periods. The result is that debt levels continue to rise, but at a pace that is roughly half of what was seen last year,” the report stated.

“The level of commercial/multifamily mortgage debt outstanding increased by $37.1 billion (0.8 percent) in the third quarter of 2023 to $4.63 trillion. Multifamily mortgage debt alone increased $26.8 billion (1.3 percent) to $2.05 trillion from the second quarter of 2023.”

Virtually every type of lender increased the dollar volume of its holdings of commercial/multifamily debt.

This has happened even though CRE mortgage borrowing plummeted 53% in the year to date. Loan originations fell 7% between 2Q 2023 and 3Q 2023 and 49% year over year – a slump that affected all major property types.

Mortgages that mature in 2024 could bring more clarity to the prospects for the CRE market – “and could force the issue for many owners,” the report stated.

“Many maturing loans have and will refinance easily – providing new ‘marks’ for the market. Maturing loans that have difficulty refinancing at terms the borrower hopes for, as well as loans that are facing challenges during their terms, may end up being another key to unsticking the markets.”

Underlying these problems are questions about property fundamentals, uncertainty about property values, and higher and volatile interest rates. “Greater certainty around these conditions is a key prerequisite to breaking the logjam of transaction activity” that has left many participants on the sidelines, the report commented, noting that the recent drop in long-term interest rates could bring relief to both cap rates and financing costs. At the same time, it pointed out that the Fed’s tight money policy could still have impacts in the future and tightening of credit is also possible.

Meanwhile, different analysts produce different conclusions on how property values are being affected.

“Most series show cap rates increasing but the pace lags the growth in broader interest rates that many look to as a base comparison,” the report said.

RCA found apartment cap rates rose to 5.2% in 3Q 2023, industrial cap rates to 5.9%, retail to 6.6% and office to 6.9%. MBA’s own models predicted a more substantial rise but said market uncertainty makes the situation unclear.

Each sector of CRE faces difficulties. Offices are grappling with how hybrid work will affect demand for office space, leaving owners to figure out which properties will be most affected. Quality of buildings rather than age, is said to be most important. Industrial and multifamily properties are facing a supply glut that outstrips demand and slows rent growth, though industrial vacancy rates remain low and rent growth remains positive. Retail, especially general purpose buildings, is seeing demand but some malls are experiencing negative net absorption.

As CRE markets confront these challenges, there has been a slow and steady uptick in delinquency rates, the report found. The share of properties with outstanding loan balances that were current or less than 30 days late fell from 97.7% at the end of 2Q 2023 to 97.3% at the end of 3Q 2023. Loans backed by office properties were largely responsible, with delinquent loans up from 4% to 5.1%. However, all sectors saw delinquencies rise, though for multifamily and industrial property the hike was less than one percent. And every capital source saw an uptick in unpaid principal balances.

The findings are based on a survey sent to leaders at 60 of the top commercial and multifamily mortgage origination firms, with a 40% response rate.

“CRE markets are entering the new year relatively stuck,” summed up Jamie Woodwell, MBA’s head of CRE Research. “Leaders of top CRE finance firms believe that a host of factors may continue to act as a drag – rather than a boost – to the markets. However, they do believe that overall uncertainty will dissipate over the year, helping to boost borrowing and lending above 2023 levels.”


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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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It’s one of the toughest questions plaguing commercial real estate today: What is to be done with a pileup of maturing — or past-due — loans worth hundreds of billions of dollars when refinancing is all but impossible?

For most of this year, and seemingly since the pandemic began, the most common solution has been to extend loans until financial conditions improve. But any relief on interest rates remains off in the distance, and the most prolific class of commercial real estate lender, regional banks, is under pressure to get CRE off its books.

Barring a shocking economic reversal, some regional banks will be forced to make a deal or foreclose on delinquent loans, which continue to rise in number. One form of deal that could rise to prevalence is the discounted payoff, or DPO, debt negotiators told Bisnow.

“The discussions about [DPOs] are increasing,” said Amy Hatch, vice chair of law firm Polsinelli’s financial services litigation practice. “I can’t say I’ve seen a bunch closing or a bunch happening, but I think it’s on people’s radar as a tool, probably more than a year ago when we were talking about extending to see what happens or finding options for borrowers.”

A discounted payoff is when a lender agrees to be repaid at a lower price than the outstanding balance on a loan. A borrower typically offers a DPO if it has financing lined up, either in the form of a buyer who agrees to pay the DPO price for the building or by obtaining a new loan to retain possession.

When a lender accepts a DPO, it realizes the loss of a loan’s value on its books. For banks, there is no functional difference between a DPO and selling the loan for the discounted price, Newmark Loan Sale Advisory Group Executive Managing Director Brock Cannon said.

But Silicon Valley Bank’s collapse in March came after it sold $1.8B worth of assets at a loss and announced the need to raise more capital, prompting a run on deposits that spiraled out of control. And even though many surviving regional banks want to decrease their exposure to commercial property loans, they have been unwilling to take the losses that doing so would require, whether through outright loan sales or DPOs, Cannon said.

“If you were hearing about DPOs, then it would mean a lot of lenders are taking a lot of losses right now, and it’s just not happening,” he said. “They don’t have the pressure on them to sell loans at a big discount.”

Darkening Skies

The Federal Reserve is poised to raise interest rates again in the next few months and keep them higher for longer than the market expected even six months ago, based on comments Fed Chair Jerome Powell made at the Federal Open Market Committee’s September meeting.

Interest rate hikes put downward pressure on property values, but the uncertainty of where they will end up and how long they will stay there has paralyzed the acquisition market since the second half of last year.

Green Street’s Commercial Property Price Index was down 16% in August from its March 2022 peak, but a lack of sales and appraisal-triggering refinancing deals makes high-level data less useful than it is in most years, Newmark found in its second-quarter U.S. capital markets report.

The collapse in transaction volume this year is making it difficult for anyone to agree on how much properties are worth as maturity dates approach and, in many cases, pass by, MSCI Chief Economist for Real Assets Jim Costello said. Borrowers and lenders are finding themselves at odds in negotiations over extensions and/or workouts.

“I put a low probability on the notion we go back to 2021 and early 2022,” Costello said. “The only other way this could change is if current owners give up the ghost and come to the realization that holding out for market-high prices might not be viable given how much things have changed.”

Second-quarter U.S. debt research reports from Newmark and credit analytics firms Trepp and MSCI all found that much more debt is still on track to mature this year and next than further in the future. The numbers of new loans and willing lenders have plummeted. And delinquency rates continued to rise for CMBS loans across most property types.

“It feels like we’ve been talking about this for a long time, but we’re still early,” CohnReznick Debt Restructuring and Dispute Resolution Managing Director Debra Morgan said. “There’s probably another rate hike or two coming, so the market hasn’t settled into loss, it hasn’t settled into recovery, it hasn’t settled into anything yet.”

Still Extending, Still Pretending

Plenty of borrowers are seeking creative solutions like DPOs and injections of rescue capital like bridge loans or preferred equity as they search for any way to avoid lump-sum payments and the consequences of being unable to come up with the cash, Hatch said. A similar sentiment has been echoed at multiple Bisnow events in the past month, including the 2023 National Finance Summit in New York.

In an environment of falling values and scarce, expensive new debt, discounted payoffs can be beneficial to both borrowers and lenders if extension negotiations and refinancing searches are going nowhere, Related Cos. Fund Management Senior Vice President Sam Friedland said at the National Finance Summit.

Hatch advised on a DPO deal that closed on Thursday, she told Bisnow.

Owners of maturing loans are doing whatever they can to get borrowers to put up enough cash to justify an extension or otherwise keep loans on their books as performing assets, all while facing intense scrutiny over the health of their balance sheets.

“There’s just a bad gap between what borrowers are willing to pay and what lenders are expecting,” Cannon said. “Borrowers aren’t motivated to sell their property to pay down loans right now. And that’s a big mistake lenders are making, letting borrowers drive the bus.”

In Q2, banks “charged off” $459M of office-backed debt, meaning they accepted that much in future losses for loans on their balance sheets, according to Trepp data. That was more than triple what banks charged off in Q1, which at $149M was also over triple the $49M banks charged off in Q4 2022.

Net charge-offs also rose sharply for hotels in Q2, while multifamily net charge-offs rose modestly, Trepp found. Even though short-term loans backed by apartment buildings should be especially damaged by the changes to the economy in the past year and a half, government-sponsored entities Fannie Mae and Freddie Mac are performing their function of keeping liquidity alive in multifamily, the Mortgage Bankers Association found in its Q2 omnibus report released Friday.

Lenders are still more apt to write down, or charge off, the value of a loan as it sits on their books than accept a DPO, Cannon said.

“I don’t understand the marks they’re writing down to. No one really does,” Cannon said of banks. “But it helps them change the performance of the loan on the books. If you do DPO with a borrower, you’ve got to report that as a loss. It’s like if you do a loan sale at 50% of par, you have to tell your investors that, especially if you’re a public bank.”


Something’s Gotta Give

What helped restart debt markets in the wake of the Global Financial Crisis was the Federal Deposit Insurance Corp. selling the loan books and foreclosed properties of hundreds of banks that had failed, Cannon said. Only three banks failed this spring, but the resulting crisis of confidence accelerated banks’ retreat from commercial lending, according to Newmark’s Q2 report.

The FDIC is marketing Signature Bank’s $33B commercial loan portfolio for sale in what could be a watershed moment for pricing comparisons. For now, lenders are using extension negotiations to clean up their paper, like getting borrowers to waive liability clauses, CohnReznick’s Morgan said.

“Forbearances until the first quarter of next year I’m seeing a lot,” she said. “We’re either going to see a bunch more forbearance agreements in the Q1, or we’ll see paper being sold.”

One public company has made a DPO deal in the past two months: Retail REIT Urban Edge Properties paid $72.5M on what had been a $117M CMBS loan for a mall in Puerto Rico by exercising an option added in a 2020 modification, it announced Aug. 30. Urban Edge obtained a new $82M loan from Banco Popular de Puerto Rico to pay for the DPO. The company declined to comment through a spokesperson.

Lenders will be more likely to accept DPOs on office buildings if and when they accept the reality that those properties have lost a large chunk of value, Cannon said. For all sectors, acknowledging that the environment is unlikely to improve until 2025 at the earliest is only a matter of time for many lenders, Hatch said.

“It makes more sense right now for a lender to say the borrower put it out to the market, this is the highest value they can get, and this borrower is otherwise going to default,” she said.

Avoiding the expensive and drawn-out foreclosure process would be among the most likely reasons for a lender to agree to a DPO, Hatch and Morgan said. Rising delinquencies indicate that more and more borrowers are losing the patience or the ability to keep up with payments on the property, which all but forces a lender’s hand.

“The more recent discussions I’ve had on [DPOs] is just lenders making the decision in the current market that they’re not seeing a lot of upside to going through the enforcement process,” Hatch said. “That would involve becoming the owner of those properties and trying to sell them at a better price.”

In addition to acknowledging a property’s loss of value, a lender could be convinced to agree to a DPO because doing so would free up some capital to make new loans, Morgan and Hatch said.

Even so, extensions and short-term forbearance agreements are still the most common resolutions being reached this autumn, as the holidays rapidly approach and complex deals seem less likely to get done before the end of the year, sources told Bisnow. But the longer lenders delay their final decisions, the more appealing DPOs could become.

“We’re starting to see more banks calling us, saying, ‘Uh-oh, we should have sold that loan a year ago,’” Cannon said.


Source:  Bisnow