Commercial Properties Face “Refi Reckoning”

The commercial real estate market is in for a rough ride this year. Many mortgages become due in 2023, and refinancing could be impossible for some property owners because of high interest rates. That situation is expected to shake things up a bit, and lead to more defaults, subleasing, and vacancies. As a MarketWatch headline suggests: “The party is over in commercial real estate.” (1)   Hi, I'm Kathy Fettke and this is Real Estate News for Investors. If you like our podcast, please subscribe and leave us a review.   Lenders say there’s an estimated $450 billion worth of commercial real estate loans coming due within the next four years. Property owners will be forced to refinance at much higher interest rates, for properties that may have also lost value. It’s a double whammy that could result in property sales and/or bankruptcies.   Higher Rates & Lower Valuations   And that’s not including a decline in lease renewals, which is already happening. You may have seen headlines about some of the big tech companies cutting down on their square footage – companies like Amazon, Meta, and Salesforce.   According to Western Asset Management’s Greg Handler: “You had all these large tech companies signing big new leases, which was getting the market comfortable with the idea that the office sector was going to recover over the long term.” But with many companies retreating, Handler says there are big questions as to “who is going to pick up the extra square feet, and at what price.”   As MarketWatch reports: “Landlords tend to default when debt comes due and financing dries up, a situation that can be exacerbated when a property’s cash flows or valuation falls.” Bank of America’s Alan Todd says of the situation: “If you’re in a property where valuations are lower (and) your rate is significantly higher, how are you doing to refinance successfully?”   CRE Price Growth Slows, but Positive   Commercial property prices haven't dropped significantly yet. One index mentioned in the MarketWatch article says they are still up 7.3% for the year, and 123.5% from 10 years ago. But Todd at BofA thinks they could be headed lower by as much as 20 to 30%. He says: “You’re talking about a secular, not cyclical, change for certain property types, whether those are regional malls or some of the lower quality offices. Some of those could be fairly problematic.”   Steve Madura of Illinois’ Hilco Real Estate offered a much bleaker forecast for commercial real estate in a Bisnow article. His company specializes in distressed assets, and he says the need for companies to repay or refinance mortgages will lead to a so-called “reckoning” that will (quote) “dwarf the 2008 financial collapse.” (2)   Madura is calling the mix of high interest rates and a frozen capital market a “distress bubble.” He says distress is happening sooner than expected, and the impact could ripple through the market. As more and more borrowers face the need for refinancing, we may see more of them heading for the exit.    Distress Creates Investing Opportunities   Of course, that kind of distress creates investing opportunities, but Madura sees it as potentially too much of a good thing. He says: “There are huge rows of office buildings in Chicago with 50% vacancy rates. Do you want to convert that many office buildings to residential? That only goes so far.”   That doesn’t mean commercial investors should ignore office space. Real estate strategist Andy Graiser says that some investors believe they should wait for a better deal later this year, but he says it might be wise to grab a deal now if it’s a good property, and the numbers make sense.  He says: “The demand is out there.”    Oxford Economics expects somewhat of a downturn. Its research shows a (negative) -2.2% total return for commercial real estate in 2023. In 2022, that figure was a (positive) 4.2%. The retail and hotel sectors are expected to be the only ones that will end the year with a positive total of 1.8% and 1.2% respectively. A decline of 5% is expected for residential property. (3)   Reshuffling of Real Estate Fortunes   Although real estate experts anticipate another difficult year for commercial properties, they are also seeing the beginning of a reshuffling of real estate fortunes. Bei Capital founder Collin Lau told Bisnow that he expects interest rates to peak, plateau, or potentially decline in the first quarter.  He says: “As interest rates start to normalize, that will bring investors back to the market.” The Bisnow article goes into more depth on the topic. You can reference that article and the others mentioned int this podcast in the show notes at newsforinvestors.com. Our plan at Real Wealth is to wait until commercial property values find their floor, as we believe values are still uncertain and in some cases, a free fall. We expect to be more active in underwriting commercial property sometime in mid to late 2023. Meantime, we are focused on acquiring single-family homes in both cash flow and growth markets. With interest rates up, fewer people can afford to buy a home but still want to live in one. The demand for renters is strong, yet competition among buyers is low. Sellers are discounting prices and even paying points to buy down the rates, increasing cash flows. This is also why we are focused on building our single-family rental fund, that has an 8% target return with very conservative underwriting. You can find out more at GrowDevelopments.com.  And if you want to build your rental portfolio, visit newsforinvestors.com where you will get data on the strongest rental and growth markets nationwide, along with referrals to experienced brokers and property managers in those markets that come highly recommended by RealWealth's over 66,000 members.    Thanks for listening!   Links:   1 - https://www.marketwatch.com/story/the-party-is-over-in-commercial-real-estate-heres-what-to-expect-in-2023-11671711842   2 - https://www.bisnow.com/national/news/top-talent/distressed-asset-specialists-see-deals-in-reckoning-that-dwarfs-08-collapse-116944?utm_source=outbound_pub_58&utm;_campaign=outbound_issue_63533&utm;_content=link&utm;_medium=email   3 - https://www.bisnow.com/london/news/capital-markets/youre-probably-going-to-lose-money-in-2023-but-theres-light-at-the-end-of-the-tunnel-116993