A $90 billion wave of maturing commercial mortgages, remaining debt from the 2007 lending boom, is exposing the weaker links in the U.S. real estate market. “There are a lot more problem loans out there than people think,” said Ray Potter, founder of R3 Funding, a New York-based firm that arranges financing for landlords and investors. “We’re not going to see a huge crash, but there will be more losses than people are expecting.”
Banks sold a record $250 billion of commercial mortgage-backed securities to institutional investors in 2007, and lax lending standards enabled landlords across the U.S. to saddle buildings with large piles of debt. When credit markets froze the following year, Wall Street analysts warned of a cataclysm, with $700 billion of commercial mortgages set to mature over the next decade.
“There are a lot of headwinds currently — with the interest-rate increase, with the new administration coming in, and also risk retention,” said S&P researcher Dennis Sim. “Those three wild-card factors could also play a role in how some of the better-performing loans are able to refinance or not.”
As the growth of e-commerce eats into sales at brick-and-mortar stores, malls tend to have higher loss rates than other property types after a default, increasing the stigma for lenders, according to Lea Overby, an analyst at Morningstar Credit Ratings LLC. When malls “start to go downhill, if nothing is done to turn the ship around, they plummet,” Overby said. “The fate of some of these malls is very, very uncertain.”
On the other hand, landlords that own high-profile buildings in big cities are performing well. RXR Realty is close to landing a five-year loan to pay off $1 billion in debt that comes due in March at 5 Times Square, the headquarters for Ernst & Young that David Werner bought in 2014 for $1.5 billion.
“We are currently reviewing term sheets from a number of institutions and expect to settle on a lender within a week or so,” said RXR CEO Scott Rechler, whose firm acquired a 49 percent stake in the 39-story property shortly after Werner bought the building.
S&P analysts are predicting that about 13 percent of real estate loans coming due will ultimately default, up from 8 percent over the past two years, according to Dennis Sim, a researcher at the firm. That’s their base case, but the default rate could be higher, he said.
Some mortgage borrowers has taken benefit of the ultra-low interest rates and has piad their mortgages loans early. Other landlords with the weakest properties have failed to pay their loans and have already defaulted, further reducing the pool of loans that need to be refinanced. The maturity wall has been cut down to about $90 billion from $250 billion in 2008, according to data from Morningstar. The firm estimates that roughly half of the remaining loans will have difficulty refinancing.
The surprise election of Doald Tump raised borrowing costs, creating credit scarcity for property owners. Moreover, firms at the Wall Street are being more cautious as new regulations take effect requiring them to hold a stake in the mortgages they sell off. Other lenders are scaling back on commitments to property types and locations where problems have gotten harder to ignore. All these indicators point towards a further doom and gloom for housing sector in the days to come.