Navigating the CMBS Maturity Wall: A Guide for Landlords
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The CMBS Maturity Wall vs. Shopping Malls
The commercial office property market is currently facing a significant challenge, with a wave of commercial mortgage-backed securities (CMBS) maturing in the very near future, a gaping hole in office occupancies, and an underlying economy that has likely permanently shifted to require significantly less office space for future operations.
This situation, often referred to as a "maturity wall," is not unprecedented. In fact, the shopping mall sector is currently navigating a similar scenario, and there are valuable lessons that office properties can glean from their experience versus CMBS maturity wall formation.
Shopping malls, another category of somewhat-stranded assets, have been grappling with their own CMBS maturity wall, with over $40 billion of shopping mall mortgages bundled into bonds coming due over the next two years.
Much of this debt has been challenging to refinance, a warning that was articulated at the Structured Finance Association's industry conference. The commercial mortgage-backed securities market has shown concern about weaker shopping malls, even as investors in other financial markets are betting on a return to normalcy for hotels, offices, and cruise ships.
The Impact of the Pandemic on CMBS Maturities
The shopping mall sector's experience with CMBS maturities has been further complicated by the COVID-19 pandemic, which has significantly disrupted already-declining mall traffic and cash flows.
Delinquent CMBS backed by regional malls and other large retail properties reached $9.65 billion, representing 18.7% of all CMBS mall loans. This delinquency rate is nearly four times the 4.7% U.S. CMBS delinquency rate for all property types. The majority of these delinquencies are in secondary markets, rather than high-density urban markets.
The "Delay and Pray" Strategy and Its Limitations
The approach of "extend and pretend," where loan terms are extended in the hope of improved market conditions in the future, has been a common strategy in dealing with these maturing CMBS obligations.
However, this strategy is unlikely to produce the anticipated results unless the market's conditions improve significantly, which would require a considerable amount of luck. Markets have an acute tendency to thwart strategies reliant upon 'hope' as a vehicle. CMBS maturity walls do not get shorter or more manageable via loan extension, per se.
Office Properties and the CMBS Maturity Wall
Office properties are now facing a similar maturity wall, with a significant amount of CMBS debt coming due in the next few years. Like shopping malls, office properties have been impacted by the pandemic, with many offices remaining empty or underutilized as companies continue to implement remote work policies.
This has led to decreased cash flows for office properties, not only making it more difficult to meet their debt obligations but also lowering the present value of these properties. As mortgages are predicated upon the market value of the underlying property, this can lead to cascades of downward-spiraling property values as landlords give properties back to lenders as recourse, who then look to offload them to the market. CMBS portfolios tend to include higher-quality debt which is more likely to be paid under ordinary circumstances; however, as CMBS maturity walls coincide with other factors, this ability could be impacted.
CMBS Maturity Lessons from Shopping Malls for Office Properties
However, office properties can learn from the shopping mall sector's experience.
- First, it's important to recognize the reality of the situation and not rely on overly optimistic assumptions about future market conditions. Insurmountable CMBS maturity walls can lead to stranded asset classes. The "postpone and re-loan" strategy may not be viable in this context, and alternative strategies should be considered.
- Second, office property owners should consider the potential for restructuring their debt. This could involve negotiating new terms with lenders or seeking additional sources of financing. The restructuring process will likely depend on several factors, including the market position of the property, the stability of the asset, and the strength of the borrower.
- Finally, office property owners should be proactive in addressing this issue. This could involve taking steps to increase cash flows, such as finding new tenants or renegotiating lease terms, as well as exploring potential opportunities for refinancing or restructuring debt. A wall of CMBS maturities constitutes a potentially systemic problem for the economy but each debtor only has its own set of circumstances to which they must respond. Giving properties back to lenders en-masse, while potentially advantageous at the individual debtor level, could trigger systemic weakness and lead to reactive, rather than proactive measures to recover.
A comprehensive national workout strategy for submerged office properties could be one solution that helps to alleviate the anticipated stress.
Summing Up: Navigating the CMBS Maturity Wall
The impending CMBS maturity wall presents a significant, although visible challenge for office properties. Incentive structures for landlords and lenders are misaligned; lenders may be saddled with overvalued collateral as a result, and this could reach systemic proportions if not managed well.
However, by learning from the experiences of the shopping mall sector and taking proactive steps to address this issue, it is possible to surmount the CMBS maturity wall and position these otherwise stranded properties for future success.
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