The Wall of Maturities
I’m often asked, what is the “Wall of Maturities”? Even more so, why should we be concerned about it and what does it mean for the commercial real estate industry?
First off, what is the “Wall of Maturities”? Many people are not aware that most loans for commercial properties are not fully amortizing. Typically they are on a twenty five year amortization schedule, but the loan comes due in 7 or 10 years. What this means is that when the loan comes due, then the owner must pay it off, either through cash reserves, or by refinancing the loan. Most investors do not have the funds to just payoff the loan, so instead look to refinance the balance. For an amortizing loan, this typically is not a problem, as over the course of 7 years, the mortgage principle has been paid off by about 20%, and over 10 years, by about 30%; however, due to cash flow concerns, many of the loans coming due were interest only, and did not pay off any of the mortgage interest. These types of loans are typically under a Commercial Mortgage Backed Security (CMBS) structure.
Why is this a problem? After all, if the property qualified for a loan 7 years ago, it should qualify again right? Unfortunately, this is not that simple. In 2008 the Fed Fund Rate was the lowest it had ever been, at 0.25%. Over the last year, the feds have raised the Fed Fund Rate to 1.25%, an increase of 100 basis points from the low in 2008. This of course has raised all interest rates for all loans across the board. Although a 1.0% increase in the interest rate does not sound like much, it equates to a 20% increase in the loan payment for many of the loans. Assuming a lender’s debt service coverage ratio (the minimum ratio of a loan payment to the net operating income of the property) has remained the same, then the net income of the building must increase accordingly just to be able to qualify for the same loan amount.
Unfortunately, in addition to the increase in interest rates, we are seeing a tightening of the underwriting of lenders, especially in specific asset classes such as retail. What this means is that if a lender requires a higher debt service coverage ratio then they did previously, then they will lend less than what they would have loaned previously on a property with the same net operating income, and same interest rate. This only compounds the problem, as investors find it more and more difficult to refinance their properties to meet the lender requirements and higher interest rates.
In fact, the delinquency rates for CMBS loans had its highest increase ever in June, 2017, seeing an increase of 28 basis points (.28%) in just that month, bringing the defaults to a high of 5.75%. This may not sound like much, but compare it to the overall commercial loan delinquency rates of 2007, prior to the last real estate crash of 2008. At the end of 2007, only 2.75% of all commercial loans were in default, by the end of 2008 this increased to 5.48%, still lower than today’s CMBS market.
This article isn’t meant to be all doom and gloom, the CMBS market is only a minority percentage of the total commercial loan market. What we should take from this though is that we do need to take action now, and make plans for any assets you may own that has a CMBS loan coming due in the next year or two, especially since all indications are that interest rates are only going up.