Higher ARM Interest Rates Cause Concern for Commercial Owners

Even though interest rates are currently at the lowest levels in decades, experts indicate that commercial real estate borrowers won’t be able to take advantage of them for much longer.  The reason is that much of the current debt on commercial real estate that was put on during the height of the real estate boom years was adjustable rate, short-term debt.  During 2006-2007, many owners of office buildings, hotels, shopping malls and other commercial real estate financed their properties to take advantage of the excess equity, and now those loans will be coming due.

But lenders are going to be reluctant to refinance many of these properties, especially if they are underwater.  Where property values have fallen, lenders are requiring owners to put in additional equity, and are charging significantly higher interest rates.  According to Trepp, a company that tracks mortgages that have been packaged into securities, there are $70 billion in commercial mortgage-backed securities that are coming due this year.   Of these mortgages, Trepp indicates that $15.5 billion of fixed-rate mortgages and $12.2 billion of adjustable-rate mortgages may have serious problems refinancing their debt.

A recent Wall Street Journal article states that rates on some commercial ARMs could rise to over 5% when refinanced, greatly increasing the debt burden on these commercial properties, and possibly turning marginally profitable properties into losers.  The WSJ gives an example of how the rise in interest rates will affect certain properties.  Blackstone Group LP owns a 12-property portfolio, which includes the El Conquistador Hotel and El San Juan Hotel in Puerto Rico.  In 2007, Blackstone refinanced the portfolio with a $1.3 billion adjustable rate mortgage.  When the loan was made, the interest rate was over 5%, but fell to under 1% as rates have fallen.  The lower interest rate expense helped offset the portfolio’s lower than expected annual operating income.   However, in 2011, the mortgages in this portfolio were put on a “watch list”, according to Trepp data.  With the loan coming due, Blackstone will probably have to make additional concessions if it wants to be able to refinance and hold onto the properties.

If interest rates on commercial real estate loans rise significantly, many properties that have been able to survive in a low-interest rate environment will no longer be able to afford the extra interest burden.  Seeing the writing on the wall, some owners are already in negotiations with lenders for discounted pay-offs, according to Trepp.  While some trophy properties have risen in value, and thus can afford to refinance, owners of properties in second tier markets will have difficulties finding a lender willing to refinance without additional equity being put into the property.  According to the WSJ, analysts and industry executives say its’ hard to predict how many of the maturing commercial property loans will wind up in default because they can’t secure a new mortgage.  But Trepp and other analysts say that the delinquency rate that has risen from 0.3% to 9.5% from November 2008 to November 2011 will likely rise even further.

 

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