By Nicole Schmidt, managing partner, Oberon Securities
Whether it’s traditional bank loans, private equity or securitized financings, it’s clear that a large number of commercial property owners are facing serious credit issues. Many office tenants continued making rent payments even through COVID-19, and the work from home trend has now left them with excess space. But as leases expire, they are downsizing their physical footprints, leaving landlords with significant vacancies amid very soft demand.
According to a November 2023 article in The Wall Street Journal, “Only one out of every three securitized office mortgages that expired during the first nine months of 2023 was paid off by the end of September, according to Moody’s Analytics. That is the smallest share for the first nine months of any year since at least 2008 and well below the nadir reached in 2009, when 47 percent of these loans got paid off.”
Add to that the impact of WeWork’s recent bankruptcy filing and projected high office vacancy rates in New York City and other major markets — plus higher interest rates — and the inevitable result is lower valuations that don’t support existing levels of debt on many properties. Higher vacancy rates, higher costs of capital and lower underlying asset values present a perfect storm for property owners with debt maturities on the horizon.
Goldman Sachs points out in a recent white paper that: “These cyclical pressures have exacerbated the structural shift toward remote work, resulting in a sharp decline in property values that has reportedly led some property owners to hand back the keys to lenders.”
And Capital Economics, a consultancy firm, also recently projected that “the structural nature of this hit to demand means the 35 percent plunge in office values we’re forecasting by the end of 2025 is unlikely to be recovered even by 2040.”
Unfortunately, experience teaches us that during cycles like this one, as lenders revert to cautious postures, it can impact even relatively strong borrowers. Lenders, particularly traditional banks, may simply hit pause until they see greater stability in debt markets and occupancy trends. Underwriting becomes tighter and more risk-averse, and even borrowers with strong relationships find themselves paying premiums.
Of course, an easing of interest rates next year may provide some relief, and that increasingly appears to be the direction in which the Federal Reserve is heading. But for now, landlords should aim to become as knowledgeable as possible about options, think strategically, be proactive, transparent and communicative with lenders, utilize third-party advisors and intermediaries with relationships and credibility and consider all possible options. For example:
- Being notified by a lender that a credit facility is not being renewed and is being moved to a workout group is not necessarily the end of the conversation. Even as borrowers pursue other options, they should maintain open lines of communication with their current lenders, providing updates on new prospects, new leases, cost reductions, management changes and other business developments.
- Lenders are never eager to take over properties. Extending and renegotiating terms is almost always preferable. According to Moody’s, about half the loans that didn’t get paid off during the first nine months of this year were extended or otherwise modified. But new terms are likely to require additional equity from landlords and higher interest rate costs.
- Compelling packaging of information can significantly improve lenders’ confidence in borrowers’ credibility. Involving a third-party debt advisor who knows what’s expected and how to present information in the most compelling fashion can help borrowers navigate these tight credit scenarios.
- The debt marketplace is fluid and diverse and includes many well-capitalized players. Spreads between traditional bank financing, private equity and securitizations have narrowed. Exploring all avenues will enable property owners to evaluate any offers relative to others and increase the likelihood of obtaining the most attractive terms possible.
- Unlike banks, non-bank lenders usually have specific focal points and certain types of assets they’re most interested in financing. Navigating the non-bank lender market effectively can be challenging, and engaging experienced professionals with in-depth knowledge of the players and their products can add significant value.
If additional equity isn’t available from existing owners, exploration of the marketplace may also include considering outside equity investments and new partnerships that will make a debt refinancing possible. Reuters, in reporting on banks looking to rework loan terms, noted that in order “to stave off loan defaults, banks required additional infusion of equity capital, allowing private lenders an opportunity to provide rescue financing through mezzanine debt, preferred equity or fresh common equity.”
In the current market, however, property owners need to resign themselves to the fact that investors are going to have leverage and are going to be tough on valuations. The market will inevitably rebound, and asset values will eventually recover. But in many cases, time is of the essence. The question is whether it’s come to the point where the choice is between giving up equity at a discount from what it once was worth or losing the property altogether.
Commercial owners may be feeling squeezed right now, but their assets have intrinsic — albeit market-dependent — value. Understanding what lenders will need in order to make deals, knowing their mindsets and being able to approach them knowledgeably, credibly and with fact-based proposals can make the difference in getting through this critical juncture and moving toward longer-term success.
— Based in New York City, Oberon Securities provides sell-side advisory services to middle-market business owners seeking sale transactions or other liquidity events.