Commercial Real Estate News / Investing / Rates Remain High as Extend and Pretend Deadlines Approach

Rates Remain High as Extend and Pretend Deadlines Approach

Published: 10-17-23 Category: Investing

MyEListings' markets and economics editor and creates content about global macro events and their impact on US commercial real estate.

Recently, a growing realization has nagged the commercial real estate community: the sustained elevation of interest rates is not a transient phase but a prolonged reality.

This shift is likely to significantly impact commercial real estate owners, particularly those with looming loan maturities and expiring rate protection agreements.

The Impending Wave of Loan Maturities

A large number of commercial real estate owners are staring at an imminent wave of loan maturities. They now find themselves on the cusp of having to refinance their loans at significantly higher rates than before.

This predicament is further exacerbated by the expiration of derivative agreements made to insulate against these surging rates, namely rate swaps and caps.

While these mechanisms have been instrumental in maintaining reduced interest expenses for those with floating-rate loans, their time-limited nature means many owners are about to lose this protective buffer, with few attractive options past that point.

For instance, a comprehensive analysis conducted by Cred iQ revealed that, of the 682 floating-rate loans amounting to over $30 billion they reviewed in March, approximately 40% possess interest rate cap agreements anticipated to conclude before the loan maturity date.

The Stance of the Federal Reserve

The Federal Reserve's recent decision to maintain the federal funds rate between 5.25% to 5.5% did little to ease concerns. Jerome Powell, Chair of the Federal Reserve, hinted at possible future hikes, with purposely hawkish rhetoric.

This decision followed a projection adjustment, which now expects rates to reach 5.1% by the end of 2024, a notable increase from the previous forecast of 4.6%, and an event that would require an easing by year's end.

The Ripple Effect on Commercial Borrowers

Such developments hold profound implications for commercial borrowers: With over $310 billion in commercial real estate loan maturities by 2024's conclusion, borrowers are entering an unfamiliar landscape.

Interest rates are now at their peak in several years, and this will inevitably compel landlords to grapple with further augmented expenses.

Challenges Ahead for Office Landlords

Office space landlords are among the most vulnerable to these changing dynamics. They are not only confronting this interest rate dilemma but are also navigating a record surge in vacancies coupled with an adversarial capital market.

This challenging backdrop raises significant questions about their ability to successfully refinance without introducing substantial new equity.

For example, Piedmont Office Realty Trust, in their Q2 earnings release, disclosed an addition of $20 million in interest expenses upon securing a $400 million loan at a 9.25% rate. This move resulted in a $2 million net loss for the quarter.

Many office property owners have thus gambled and are seemingly likely to lose further by having ‘extended and pretended,' hoping for the return of normalcy in time to reward their decisions; hope, however, represents a fleeting and often ill-conceived investment.

Key Comprehensions

The prevailing environment, marked by quickly ramping interest rates and impending loan agreement and loan extension expirations, is creating a vortex of challenges for commercial office property owners.

Many office properties have extended their financing arrangements for short terms at higher cost, typically by paying for derivatives such as rate caps, swaps, options or term extensions.

Many of these structures are set to expire before their underlying loan maturities, in the case of rate caps and swaps. As property owners awaken to the new market realities, a rational next step for many could be to surrender their assets to their respective lenders.

Should the volume of these reversions reach a critical mass, a tipping point could be reached, triggering cascades of contagious effects, potentially reaching across asset classes, and international boundaries.

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