The headlines are scary. “Office-Loan Defaults Near Historic Levels with Billions on the Line,” warned Peter Grant of The Wall Street Journal on April 30, 2024. A month later, CoStar News reported that “Past Due Commercial Real Estate Loans Reach Highest Total in 11 Years.” The situation appears bleak for owners of commercial properties, especially within the office sector, where they face dual challenges of declining occupancy and high interest rates. But it is not dire, say several brokers. Some owners can still refinance, despite the harrowing landscape. And others can explore a range of alternatives.
OPTIONS
Landon Williams, SIOR, senior vice president of Cushman & Wakefield in Memphis, Tenn., views the situation for office owners as a “math problem.” As he explains: “The different parts of the equation are higher interest rates, lower loan-to-value thresholds, and lower valuations based on higher cap rates applied to lower net operating incomes (NOIs). Assuming the owners want to keep their buildings, they need to “run the equation and then figure out how to supplement the missing piece of capital either through their own infusion or through an outside partner in the way of additional debt or equity.”
Williams runs the capital markets division of his office, so he regularly helps clients evaluate the options in advance of loan maturity. These may very well include the extension of an existing loan or a refinancing. Like Williams, Gabriel Silverstein, SIOR, managing director of SVN | Angelic in Austin, Texas, prepares clients far in advance of deadlines. He says that his team looks for preferred equity to bridge any refinancing gaps and explores “creative capital stack options” for owners who don’t want to sell.
As long as I can make 5-10 new contacts with the possibility of a future deal emerging, then it’s a positive return on investment.
One option SVN | Angelic is investigating for large properties in major metros is the sale of the ground beneath a building in a long-term ground-lease structure. The building can then be financed as a leasehold, rather than as fee simple. Furthermore, a ground lease usually prices cheaper than even permanent debt interest rates, which lowers the blended cost of the capital stack.
Some owners are turning to alternative lenders, but there are downsides to these arrangements. “Alternative lenders have higher interest rates compared to a traditional bank loan and their repayment terms are usually shorter,” says Tobias Schultheiß, SIOR, managing partner of Blackbird Real Estate in Königstein, Germany. Tim Vi Tran, SIOR , president of The Ivy Group in Fremont, Calif., has seen interest rates for alternative loans as high as 12%. “It’s crazy out there,” he states.
Full transparency from day one is a key driver for success as well as the need to talk to more financing institutions than your house bank.
Another option, of course, is to give the keys to the lender. But as Tran notes, many U.S. lenders don’t want to take the property. “It’s a last resort for both parties,” he says. A discussion at the GRI RE Distress & Financing Opportunities Forum, held in London in April, suggests that European lenders are equally reluctant. An event recap reports that “Often, lenders refrain from enforcing the sale of an asset or taking ownership for lack of a better plan than the sponsor.”
Owners who wish to keep their keys need to demonstrate both flexibility and honesty. “Full transparency from day one is a key driver for success as well as the need to talk to more financing institutions than your house bank,” says Schultheiß. Although interest rates in Germany are secured for 10-15 years, he has observed that banks are currently reluctant to refinance, and extensions are becoming more difficult. Owners who have had success in refinancing are those who play “fairly and transparently,” he reports.
Flexibility applies not only to financing arrangements, but also to leasing. According to Bo Hargrove, SIOR, principal of Rich Commercial Realty in Raleigh, N.C., owners whose asset management teams are stubborn or difficult to work with for brokers or occupants have and will continue to find the conditions challenging.
OPPORTUNITIES
Hargrove has a good idea of which owners are the most flexible in leasing in his market because he is a tenant-rep broker. He and his colleagues also conduct research into property-specific challenges, and their findings influence their negotiation strategies.
The tables have turned in some respects: “In the past, owners have been very particular on underwriting their tenants,” Hargrove says. “We are doing the same in trying to understand who our landlord is going to be, what their plans for the asset are, what their financial and debt positions are, and how that could impact our occupancy decision-making.”
Hargrove and his colleagues leverage these opportunities. For example, if they see that there is a substantial amount of space available at a property for sublease, that’s a red flag. “We could potentially extract more concessions from a landlord if we have a tenant that can sign a direct lease, because the landlord wants a direct deal on the books,” Hargrove observes.
Tran believes that today’s market presents many business opportunities in all areas of brokerage. Indeed, his firm is working with data scientists to use predictive analysis and AI to identify potential clients who might need consulting help. “We’re not sitting around waiting for things to fall into our lap,” he says.
Having a solid understanding of the capital markets allows us to best advise our clients even if in some cases it only indirectly impacts them.
ADVICE FOR BROKERS
Whether they focus on leasing, sales, financing, or a combination of these areas, it’s essential for brokers to stay abreast of developments in the capital markets. “We believe that having a solid understanding of the capital markets allows us to best advise our clients even if in some cases it only indirectly impacts them,” says Hargrove.
Schultheiß regularly reads articles and newsletters about the capital markets, attends events related to them, and schedules personal meetings with financing experts when he has a special requirement. Although Williams’ specialty is capital markets, he supplements his day-to-day dealmaking and meetings with webinars, articles, white papers, social media, and podcasts about trends.
THE FUTURE
“I think 2024 is going to be a defining year,” says Tran, who points to the Federal Reserve's potential reduction of interest rates and the upcoming election. “It’s an opportunity for us to showcase our skills and adopt the right strategies to help our clients maximize their returns and mitigate their risks.”
If the market challenges persist, brokers should try to adopt Silverstein’s attitude. He reminds us of the centuries-old wisdom: “This, too, shall pass.”
This article was sponsored by the SIOR Foundation - Promoting and sponsoring initiatives that educate, enhance, and expand the commercial real estate community. The SIOR Foundation is a 501(c)(3) not-forprofit organization. All contributions are tax deductible to the extent of the law.
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