Commercial Real Estate: How Will Refinancing Take Place?

Is the consensus correct that commercial real estate (CRE) underwriting became too tight because of the panic-recession, or was it just about right?

Financing all but evaporated, as lenders searched for metrics (underwriting requirements) that limited risks in response to the recession and collapse of CRE values. In recent months, the underwriting environment has improved for properties with quality tenant profiles to levels allowing deals to happen. Loan-to-value (LTV) ratios between 65 and 75 percent are available for various property types, and debt-yield requirements have begun to decline. In addition return of commercial mortgage-backed security (CMBS) financing has also begun to add liquidity to the market.

How will the industry deal with refinancing properties financed at the height of the bubble?

Other than the continuation of “hold and hope,” there does not appear to be a plan in place to address the refinancing of properties financed at the height of the market. Lenders appear to be more active in taking possession of assets but seem willing to hold and operate the assets in order to market and sell as market conditions improve. The financial institutions may have the capital and willingness to continue this non-strategy for the foreseeable future; however, it is unclear what will happen with properties financed with securitized debt as the special servicers are forced to deal with the requirements of the pooling and servicing agreements in addressing these loans. In addition to the above, banks have been telling developers when a loan reaches maturity that current underwriting is now based on more stringent standards. The result has been that when loans are being restructured, each party needs to clearly understand the motives of the other party.

Appraisers, on their part, are being ultraconservative. Instead of using existing rents as the basis of determining value, they are assuming lower rental rates and so arriving at a lower value for the property. The property owner, on his or her part, may not be willing or able to refinance a maturing loan based on the current value of the property. The concern of the borrower is that there is a likelihood that the property will rise in value in the foreseeable future, and they will be unable to access additional financing if forced to refinance based on the current “conservative” appraised value. From the point of view of the bank or other lender, the property owner may need to agree to a shorter loan maturity or such enhancements as additional collateral or guaranties.