September 9, 2024
The CRE industry is in a state of flux with projects and acquisition activity taking off in certain asset classes, and underperformance plaguing others. Find out how Prophia’s AI solution is helping ease and fortify the process of disposition or refinancing.
The amount of CRE debt in the market has reached a critical mass. Up to this point, institutions have managed to delay addressing the substantial amount of debt due to mature in the coming months, but many experts point to 2025 as a pivotal year for finally paying off this debt and confronting the reality of this situation head-on.
The options available to mitigate the impact of this debt include refinancing, selling assets, or handing them back to the lender as well as a correction period in the markets with decreased property values, increased foreclosures, and potentially even lender losses.
The exact nature and severity of this market correction will depend on various factors, including the overall economic climate and the performance of specific asset classes, but the time is winding down on the grace period of CRE debt.
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The Current State of CRE Debt Maturities
A Better Way Forward for CRE Loan Refinancing
Safeguarding CRE Investments With AI
The Current State of Commercial Real Estate Debt Maturities
Goldman Sachs estimates that banks with less than $250 billion in assets hold a substantial 80% of commercial mortgage loans. This concentration has heightened scrutiny on small to mid-sized financial institutions as a significant portion of these loans mature over the next 4-5 years.
However, the risk landscape for commercial real estate loans is not uniform. Certain asset classes face greater exposure than others and will require greater care when refinancing or handing assets back to the lender.
Retail
It’s no secret that the retail sector has made significant strides since the Covid pandemic and the online shopping boom. In up-and-coming cities like Raleigh, NC, retail vacancy has decreased to 1.8%. Similarly, retail vacancy in major cities like Boston and Atlanta also sits at an impressive 3%, and Manhattan has reported the lowest retail vacancy rate in approximately a decade (14%).
What does this mean for loan maturity? In an interesting correlation, retail markets have “largely dropped in criticized loan share from Q4 2021 to Q2 2023,” according to Trepp’s Anonymized Loan-Level Repository (T-ALLR) data set. The Miami retail market’s criticized share reached 15% by Q2 of 2020. By Q2 of 2023, that rate dropped to 1.5%. This stunning reversal is largely attributed to many high-end retailers, restaurants, and residents moving to Southern Florida in recent years, backing luxury retail projects and driving tourists back into the area.
Despite a seemingly healthy retail leasing market, servicers are raising alarms about a wave of high-value distressed CMBS loans in cities like Boston and Chicago. Many of these loans are already delinquent, and others are facing imminent deadlines. This looming challenge is set to trigger a flurry of CRE refinancing and disposition activity heading into the new year.
Industrial
The symbiotic relationship between retail and industrial real estate is undeniable. As Bob Fordi, CEO of Realterm, noted on Bloomberg TV, retail's progress hinges on the massive industrial development boom of the past four years. Over two billion square feet of industrial properties have been added to the market—an area three times the size of Manhattan.
This industrial surge has made the sector the third-largest pool of maturing debt, totaling $110 billion. While a significant portion of these loans are due to mature in the coming months, industrial properties remain highly sought after by lenders. Consequently, the CRE refinancing and disposition landscape for industrial assets is likely to diverge significantly from office and multifamily over the next 18 months.
Healthcare
Healthcare CRE remains a bright spot in the post-pandemic landscape. According to BisNow, healthcare loan originations surged by 50%, reflecting strong lender confidence. As Jamie Woodwell, MBA Head of Commercial Real Estate Research, noted, "Most capital sources are eager to invest in properties that can support a loan."
Beyond the surge in loan originations, healthcare's resilience is evident in its maturing debt: a mere $19 billion compared to multifamily's $257 billion and office's $208 billion. This underscores healthcare's status as a prosperous and relatively risk-free investment opportunity.
Office
The office sector faces a challenging road to loan resolution, marked by a potential industry-wide reset in asset values. Numerous market factors will complicate this process over the next 18 months.
One significant hurdle is the stark disparity in office demand. Prime Class AA properties in high-demand locations like Lower Manhattan's Hudson Yards continue to thrive, while Class B assets in suburban areas struggle to attract tenants. This divergence is exemplified by the contrasting fortunes of Century City, Los Angeles, and downtown LA. Century City's booming development and increased demand have led to a downtown LA exodus and a surge in defaulted mortgages, totaling $2.2 billion since 2023.
With $206 billion in office loans maturing in the coming year, property owners face a critical decision: default or refinance. While refinancing is often the preferred option, rising interest rates pose a significant challenge. Many owners who locked in loans at lower rates during the pandemic may find current rates unaffordable, making refinancing difficult or impossible.
The takeaway is clear: the office sector's recovery will be highly individualized. As Scott Morse of Citadel Partners noted, "Prudent borrowers who acquired properties five to seven years ago and can extend their loans should weather this downturn." However, the extent to which these borrowers represent the overall maturing debt remains uncertain, keeping servicers and experts vigilant as 2024 draws to a close.
A Better Way Forward for Owners Who Choose to Refinance Commercial Property
The current market has created financial challenges for property owners in underperforming asset classes. Many are unable to refinance their loans due to high interest rates, while others need help to sell their assets amid low demand. For those grappling with these difficulties, Prophia offers a solution to streamline the refinancing or asset return process, helping to minimize financial burdens and maximize outcomes.
Lease Abstraction
Offering memorandums on average are missing at least three critical documents. If financial statements aren’t represented accurately in an OM or an asset’s current risk exposure is not fully disclosed, the buyer or lender can take legal action against the property owner which can sink ownership into a deeper financial hole.
With tenant and property data captured and centralized within our platform, Prophia’s AI acts as a real-time ledger, signaling important upcoming critical dates on an asset, flagging property encumbrances, and upcoming vacancies. Other source-fed data includes:
- Rent roll data
- Stacking plans
- Tenant reports
- Cash flow records
- WALT and average in-place rent
- Future dates
- SF leased and occupied
- Total rentable SF
Prophia serves as a valuable asset for businesses and individuals involved in asset turnover. By automating the data collection and categorization process, it streamlines operations, reduces risks, and empowers stakeholders to make informed decisions.
Align third parties throughout the process.
Prophia streamlines data sharing, making collaboration effortless. For due diligence, leasing, disposition, and refinancing, Prophia acts as a central hub—the source of truth—and allows unlimited, controlled user access to third parties, saving time and ensuring everyone has the right information at their fingertips. No more manual reconciliation or back-and-forth. Prophia simplifies the process and accelerates knowledge-sharing while protecting intellectual property.
Reconcile important documents.
Selling, refinancing, or returning an asset requires precise financial data. Missing or misplaced documents can significantly delay the process. As we’ve stated, our research indicates that, on average, OMs lack at least three crucial documents. Prophia's rigorous quality assurance ensures document accuracy, guaranteeing that purchasers, lenders, and sellers always have the correct number of documents for important transactions. Our AI and in-house team meticulously review each reconciliation, ensuring no documents are overlooked and every party can proceed with confidence.
Build strong fundamentals and futureproof a portfolio.
Important business activities and decisions don’t stop after the lease is signed. Prophia offers full-scale and comprehensive data management support throughout the tenant and property lifecycle. This includes providing property owners and operators with real-time analytics, flagging important asset milestones or tenant critical dates, and keeping owners abreast of financial exposure throughout the life of a lease. This is all incredibly useful for building strong fundamentals and circumventing losses before reaching the point of offloading an underperforming asset.
Prophia for Safeguarding, Refinancing, and Disposing Assets
As the commercial real estate debt maturity landscape evolves, property owners face increasing challenges in refinancing, selling assets, or returning them to lenders. The complexities of the market, coupled with the potential for financial and legal risks, necessitate a strategic approach.
Prophia offers a comprehensive solution to streamline these processes, including coverage for the “little things” like automated lease abstraction, building investor reports, and simplifying daily operations. By effectively managing every small moving part, Prophia empowers owners to navigate the larger complexities they face in the market or when managing their portfolio.
To learn more about how Prophia can help your organization, contact us today.