Unstable markets make investments safe, so hearing the state of the refinancing market look like a kaleidoscope isn’t too reassuring.
However, as Brad Zampa, executive vice president and senior partner of CBRE’s Northern California Capital Markets team explains, the environment for commercial refinancing, particularly for less desirable office properties, has become uncertainty free. of today.
“The office market is a falling knife right now,” Zampa said, adding that the situation is dire nationally but especially in the West Coast markets it covers, including San Francisco, Los Angeles and Seattle. “The richest 10-20% of buildings in any central business district will capture the market share of workers returning to the office. And we are left with a huge band of buildings that no one knows about “.
The unknown concerns both present data and future activities. It is incredibly challenging to evaluate buildings and finance them, because rents are constantly changing and creating comps is challenging. Buildings can be rented out but remain significantly unoccupied or underused, creating significant obstacles for lenders and owners.
“The lenders are saying, ‘Nobody is here, how do I sign up for this?’ ”Said Zampa. “They are just taking buildings with good tenants, and that’s a big deal.”
Many expected that the post Labor Day period would mark a full-scale return to office. That hasn’t happened yet, with prominent companies like Apple and KPMG instead announcing upfront a hybrid approach to the workplace where workers arrive in a few days a week at most. Security firm Kastle Systems, which tracks access to offices, has set national office occupancy in major markets at 43% for most of August.
The pain is not evenly distributed across the markets. Some have seen more signs of life and real estate activity than others. But with many companies shrinking their footprints and anticipating a rising recession, owners and operators face growing challenges, including refinancing. And lenders backed off, with the Mortgage Bankers Association (MBA) forecasting a slowdown in commercial mortgage issuance in the second half of the year.
“The market is very fluid and each deal is signed differently depending on the risk,” said Susan Hill, senior chief executive of capital markets at JLL. “The market is liquid with more control over underwriting assumptions and real-time market data.”
That risk, Zampa said, has kept significant sectors of the capital market, most notably big banks and the CMBS world, on the sidelines for all but the safest deals. Some regional banks are trying to step in and take market share that would usually lose to bigger players, but it’s not making a difference. Hill added that smaller, local or regional banks or credit companies handle much of the refinancing of Class B and C buildings. These companies are “flooded” with loan applications.
Difficult conditions for financing will hit Class B and C office buildings hard, Hill adds, especially those who find it difficult to add more common services and spaces, or reside in places that are not walkable. Offices with solid tenants and good business plans will likely still be able to do business. In August, a $ 128 million refi for 77 Water Street in Manhattan broke through banking reticence thanks to strong tenants, including a law firm and the Arup engineering firm.
“There is still a big unknown as to how the office will change in the future,” Hill said.
Commercial real estate refinancing in general has soared in recent quarters, rebounding significantly after a decline during the first months of the pandemic. According to the MBA research, an overall 23% increase in commercial property values last year offered plenty of reasons to refinance. In the first quarter of 2020, commercial refinancing counts were 31,383, according to ATTOM Data. That number declined throughout the rest of the year before increasing in the fourth quarter of 2020 and reaching a high of 46,434 in the second quarter of 2022 (the highest total since the second quarter of 2008).
“Last year we were in tears,” said Zampa. “Many of my competitors were having a fantastic year, if not the best.”
Such statistics can hide the challenges faced by older office properties in particular. Zampa noted that the apartment market is still the most liquid in terms of financing, followed by industrials, then life sciences, segments that have grown in demand and investment at consistent rates.
Furthermore, ATTOM data does not show the current bifurcation between the office sector. The latest high-level Class A actions can find the refinancing needed to maintain and upgrade and to add the kind of post-pandemic services – enhanced common and collaborative space, indoor-outdoor space and technology – that make them even more desirable ( and justify higher rents to pay today’s higher financial burdens). The rest of the market, especially significantly older buildings, face the shock of rising interest rates with less occupancy.
Adam Gibbons, chief investment officer of CIM Group, a large investor, told the Commercial Property Executive in March that CIM is “very, very cautious about lending older Class B commodity products where there is no path. clear on how and when those buildings will be rented ”.
Zampa says owners in those situations can’t get extensions on their loans, so he suggests asking their lenders for a repayment and extension. Takeout financing simply isn’t there otherwise, and their payments could triple in the current interest rate environment.
“Extend until 2023 and live to fight another day,” he said. “Taking 7, 8 or 9 percent to save your building, this is a trap.”
Many office owners may not have enough money to float their loans for another year. “Cracks are forming,” Zampa said. Without sufficient liquidity to obtain new loans, there could be a very difficult 12 to 18 months for less desirable office property owners who lose, or cannot attract, tenants and have little or no income. Prices are expected to drop substantially for developers to make a large-scale push for expensive office-to-residential conversions, or for investors to see a value play in troubled assets.
“It looks a bit like 2010, 2009, but there is a fundamental change in the way we use the office,” said Zampa.
Jamie Woodwell, MBA vice president for commercial real estate research, agrees. Unlike previous recessions, where companies went bankrupt and then discharged their lease obligations, immediately hurting landlords, tenants aren’t disappearing unexpectedly. So it takes a lot longer to figure out where companies are and how much of their footprint they will eventually give up, and the loans continue to work well.
Zampa said his team even discussed what cities can do to help stabilize the situation, such as corporate tax incentives triggered by occupation and office use, to help push companies to report. employees in offices. There is a need to restart urban centers in some cities or to risk a significant reduction in tax revenues and the consequent municipal budget crises.
Analysts are hoping the office market will hit low so they can get comps to subscribe and get data to triangulate the value.
“We really need our cities to come back and I’m not sure where that happens,” Zampa said. “The market is completely frozen. This is the moment when you hug your banker. “