April 2023

• The current stress in the economy may put significant pressure on commercial real estate owners who need to refinance their property.
• The options to refinance may be severely limited in the current market.
• But there are alternatives to refinancing that a property owner can explore.

In last week’s article, I wrote a lot about how the outlook for our economy right now may not be the rosiest. And while that’s not a very fun topic to think about, it is best to be prepared for it. And, potentially, take advantage of the opportunities it provides.

One specific area that has tightened significantly is the debt markets. There are a lot of owners that, when they purchased their commercial real estate, had short term debt on it. And that debt may mature soon. But unfortunately it may be difficult for them to find new debt to refinance the property.

So if you are in that position, what are your options? That’s what I am writing about this week.

Owners Have a Few Options if They Cannot Refinance

In some ways, this climate reminds me a little of the 2008 time period. Now, of course, I do not expect it to be anywhere near as dramatic or significant as that time. But there are some similarities. Especially the part where commercial real estate owners had trouble getting access to debt to refinance properties.

You likely recall, at that time there were a lot of foreclosures as banks likely thought they had no choice but to take back the property. I thought this would be an even more attractive option to lenders now because there is likely more equity in the real estate that the bank has debt on. But I recently spoke with a banker and he assured me that the banks do not want to own commercial real estate.

So what does that mean for commercial real estate owners who are facing expiring debt with limited refinance options? There are a few alternatives, including:

• Workouts – Specifically, I mean renegotiating the current debt on the property. This was very popular back in 2008. And still think it’s a possibility because, as that lender told me, the banks do not want to own commercial real estate. So your lender is very likely to work with you in lieu of foreclosure. If it can be done, it is by far the best option because it allows you to keep the property and not have to find new debt somewhere else. I do recommend starting the discussion with your lender sooner rather than later.
• Default – Unfortunately, there are times when your lender just will not entertain a workout. In that scenario, you may need to go into default. That may be the only option that brings the lender to the table. Obviously this comes with significant risk, including but not limited to additional fees, potential foreclosure, receivership, etc. But it may be the only thing that brings the lender to the negotiating table.
• Sell the property – This may not be the most ideal solution because selling a property under duress can lead to a rushed sale for a lower price. But if its your only option, you may not have much choice.
• Bankruptcy – Putting the ownership entity into bankruptcy should be a last resort for any property owner. It may violate the bad boy provisions of the loan and activate a personal guarantee by the sponsor. And the sponsor may have significant difficulty getting future debt for a property. As a result, we rarely recommend this action unless there is significant built up equity in the underlying asset.

Your situation may dictate that there are more options than the ones listed above. But these are a few of the most common choices. And they all assume that you cannot find other debt in the market. And that may not necessarily be true.

I wrote last week that the debt markets have tightened up. And that’s true. But they are not completely frozen. There are alternative debt structures out there that may be able to help with a distressed asset. Some may require a personal guarantee, for example. But at least you get to keep your commercial property.

We have a lot of contacts in the debt world so if you need to find a new lender, please let me know. And also call if you just need some help navigating the world of difficult refinancing and want to discuss your options. We would very much like to work with you to protect your commercial real estate investment.

• Recent bank failures and bailouts have raised uncertainty in the debt markets.
• In addition, the fed continues to raise interest rates to combat inflation.
• As a result, there may be opportunities for buyers of distressed assets in the near future.

I like to generally be upbeat and positive. Its not always possible, but I think if you can look at the sunny side of life, it’s a nicer way to get through a day. That’s quite an introduction to a blog article talking about the state of the economy, eh?

But now is the right time to check in on the economy. We all know about the recent bank failures, the rise of interest rates, the high inflation – its all lead to some significant uncertainty in the markets. But what is next? Where is the economy going? And what does it mean for the commercial real estate industry? Well that’s what we are going to talk about this week.

Bank Failures Significantly Impact the Commercial Real Estate Markets

Its been a pretty rough few weeks for the banking industry. The most shocking was probably the Silicon Valley Bank failure. It was amazing how quickly it went from allegedly doing well to a complete failure. That was followed shortly thereafter by Signature Bank and Credit Suisse effectively being rescued.

These failures obviously create a lot of uncertainty and tension in the market. And that uncertainty creates problems in the credit markets. When a bank fails, it often results in a decrease in the supply of credit, which can make it harder for businesses and individuals to borrow money. This can lead to a decline in economic activity, as businesses are unable to invest in growth or hire new employees. In addition, the failure of a bank can lead to a loss of confidence in the financial system, which can lead to a broader economic downturn.

The tightening of credit markets can also have an impact on interest rates. When the supply of credit decreases, lenders may raise interest rates to compensate for the increased risk of lending. This can make it more expensive for borrowers to access credit, which can further slow economic activity. That is about where we are now, as I am sure you have all seen a tightening of the credit markets.

Fed Continues to Raise Rates

In addition to the bank failures and tightening credit, the Fed continues to fight inflation. On March 22, the Fed once again raised interest rates another 0.25%. This was the ninth consecutive rate hike. Chairman Powell reiterated that the Fed’s goal was to get inflation down to 2%.

The latest twelve-month inflation data showed an inflation rate of 6% for February. So theoretically, at least, the Fed still has a long way to go. If that’s true, and the Fed agrees, we could continue to see more interest rate raises for the near future.

What All this Means for Commercial Real Estate

So what does this uncertain news mean for commercial real estate? Its not great. Not only are the debt markets incredibly tight because of the uncertainty in the banking industry, but even if you can get a loan, the interest rate is very high.

Obviously that could negatively impact buyers who are looking to acquire some properties. Because of that, we have seen, and will likely continue to see, cap rates increase across the board for commercial assets. It seems like sellers are starting to acknowledge the cap rate expansion and, as a result, the value of properties is decreasing.

This also could present a serious problem for anyone who needs to refinance a commercial asset. If you have a property that needs to be refinanced, it may be very difficult to find another loan for a rate that will not severely disrupt your cash flow. As a result, there may be current owners that are in trouble and looking to sell. Combined with widening cap rates, that could provide a lot of opportunity for buyers.

This is just one man’s opinion and I could be wrong. But if I’m not, there may be some choppy waters ahead for commercial real estate.