At Hallmark Abstract Service we attempt to provide clients with information they hopefully find timely and useful that they potentially may be able to share with their own clients.
With that in mind, we wanted to offer an overview of commercial real estate mortgages and some of the issues surrounding what for many buyers is a time that’s fraught with angst and anxiety.
The 5-year anniversary of their mortgage being originated!
Commercial Real Estate Financing and Refinancing!
For some owners of commercial property who are facing the 5 or 7-year anniversary of their mortgage having been originated, it’s possible that it may not represent the happiest of times.
This is because a great many commercial mortgage loans made in 2007 will balloon at some point in 2012 and need to be refinanced. Given some of the issues that will be discussed below, in many instances this will be far easier said than done!
It was back a few years during the “Golden Age” of commercial and residential real estate when property values appreciated at a dizzying and ultimately unsustainable pace, rent increases could be imposed and tenants actually were paying their rent.
Coincidently the underwriting parameters and guidelines at some lenders allowed for them to close loans with borrowers who possessed both property and personal financials that at another time may have been considered to be marginal or even sub-standard.
Essentially many of those parameters and guidelines being used, with the help of 20/20 hindsight, never should have been.
This is because due to the laws of physics and economics a “bubble” can grow unfettered for only so long and become just so large until eventually the time comes when they can no longer contain the air and will burst!
This was a classic high-stakes game of musical chairs in which you didn’t want to be the last one standing when the music stopped because if you were, the result could be devastating.
Fast Forward to 2012
In today’s commercial property market, as most who are reading this article will know only too well, occupancy rates in many of the commercial real estate sectors are down, rents are being renegotiated down by tenants and bank underwriting parameters have tightened credit availability to the point that the only borrowers who can qualify for a loan are the ones who don’t actually need it.
Concerning value, if you assume that capitalization rates have merely stayed the same between 2007 and 2012, the value of a commercial property based on the net operating income that it’s generating with lower occupancy and with lower rents being paid, will be substantially below what it was at the time of purchase.
Using as an actual example the Omni office complex near the Nassau Coliseum has a $108MM loan outstanding. The occupancy rate has dropped from 92% to under 80% and almost 10% of current occupancy will be up for renewal this year. While still current on the mortgage, the monthly cash flow being generated by the building has gone below the monthly debt payments.
Fortunately for the owners the 10-year note has a maturity date of 2017, but if the building fundamentals don’t improve the question would be for how long and for what amount of money the owner will be willing to subsidize deficit spending before they simply stop making the payments altogether (Source: LIBN, June 8-14th Issue).
While the Omni is one of the finer commercial properties on Long Island and will likely find tenants for their vacancies, imagine the problem for a marginal to poor quality borrower who owns a C property with 50% occupancy and where tenants can now move-up to a B quality space for less money than they are paying now.
This all has contributed to a Long Island rate of commercial mortgage loans in foreclosure or 60+ days delinquent of more than 7%.
Good news on the horizon?
That’s the bad news, but a silver lining may be beginning to emerge as default rates are showing signs of decline and banks are showing signs of loosening underwriting standards.
Typical of commercial real estate, different sectors of the market will enjoy varying levels of success at different times (multifamily is currently in favor with lenders), but any good news whether anecdotal or not needs to be embraced.
The bottom-line? For the knowledgeable investor that does their homework, the current issues plaguing the CRE market provides the potential for some fantastic opportunities!