Commercial Real Estate is Starting to Feel the Pinch from Higher Interest Rates
As loans renew or expire, increased debt service costs are pushing property owners are going into default
If you’ve traversed real estate circles over the last two years, you’ve almost certainly heard that commercial real estate owners are in for a world of hurt as loans hit their balloon and they are forced to either sell or refinance or renew at a substantially higher rate (a 30-year mortgage is at 6.94 percent as of this writing whereas it was under 3 percent in mid-2021).
Most commercial loans are five years and almost never are they over 10. So given rates started to rise in mid-2022, we will be dealing with the consequences of loans resetting at higher rates for another three years.
Add to this, rent growth has slowed and vacancy has increased somewhat over the last few months.
Based on Freddie Mac delinquency data, Bill McBride at Calculated Risk notes,
“…the multi-family serious delinquency rate increased sharply in January to 0.44% from 0.28% in December, and up from 0.12% in January 2023.
“This graph shows the Freddie multi-family serious delinquency rate since 2012.”
While 0.44 percent is much higher than the almost non-existent rate between 2014 and 2019, it’s still not terrible and nowhere near where it was in 2008. But the trend is rather concerning, at least for commercial real estate. Residential real estate is still quite strong despite the higher interest rates.
We made a point of refinancing as much of our debt that was renewing in 2023 and 2024 as possible in 2021 and 2022. This has certainly bought us some time, which is nice.
Still, there are options for those with loans that are hitting their balloon, at least for those who are working with lenders that have some flexibility.
For one, the market is still rather strong, even for multifamily. So selling is definitely a possibility. But what we did on one loan that we didn’t refinance that just recently renewed was refinanced it at its current principal, i.e. we pulled no money out.
Effectively, we just reamortized the loan. Given the principal balance is substantially lower now than when we first took out the loan, the payment will be quite similar despite the rate being 3 percent higher. Yes, we’ll pay off less principal each month, but cash flow won’t be a problem.
Of course, this requires having a decent amount of equity in the property to do, but since these loans are usually at least five years old and there has been substantial appreciation over the past few years, many property owners should be able to do this.
Either way, it’s important to have a plan in mind as interest rates on your properties reset. And economy-wide, we can expect commercial delinquencies to continue to increase over the next few years.
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