Real Estate’s Finance Class Sees Hope And Distress For 2024 At CREFC Conference

All eyes are on the Federal Reserve as commercial real estate deal-makers flocked to Miami Beach this week. 

Following an 18-month period during which rising interest rates punished deal volume to the point that most major brokerage firms implemented layoffs, real estate investors are restlessly awaiting interest rate cuts that they expect to unlock capital just as lenders become more aggressive with distressed borrowers.

This dynamic will boost acquisitions and force sales at discounts, industry players told Bisnow at the Commercial Real Estate Finance Council's biannual conference on Monday. 

“The fence-sitting that's been going on between lenders and borrowers is going to come to an end in 2024,” said Tad O'Connor, co-chair of real estate litigation practice at New York-based Kasowitz Benson Torres. “You're going to see more contentious resolutions of things than what has been happening really since the pandemic, which was just kicking the can down the road.”

While asset values are expected to fall in the year ahead, primarily in the office sector, the mood in the halls of the Loews Miami Beach was decidedly buoyant on the first day of the conference. 

Investors, lenders and intermediaries expressed optimism in conversations that distressed assets will begin to trade as the Fed embarks on rate cuts — although they disagreed on when. As lender appetite for loan extensions wanes, they expect more owners of struggling assets to become resigned to the prospect of either selling at a loss or surrendering their properties altogether.  

“You're starting to see equity that owns an asset willing to just turn it over to the lender without fighting,” said Craig Phillips, a former official at the Treasury Department who recently launched an asset management firm targeting distressed assets called Oculus R Capital Partners. 

Conference attendees said the Fed has largely succeeded in sticking a soft landing, but the potential for a recession in the back half of the year still looms. Loans that were extended on the tail end of the pandemic with one-to-three-year terms are coming due along with longer-term debt, leading to a pileup of loan maturities.

“It's actually pretty surprising how many relatively short-term loans there are that were done after Covid that are now maturing,” O’Connor said. “People's expectation was that they were going to mature into a different world, and this world is as uncertain as it was in 2022 and 2023. A lot of the hopefulness is gone.”

The Mortgage Bankers Association estimates that there’s $4.5T in loans currently held by lenders, with 60% of that debt due in the next four years. Economists at the National Bureau of Economic Research say that around 44% of office properties are underwater on their loans, and $117B in mortgages are slated to mature in 2024, according to the Mortgage Bankers Association. 

There was an expectation among conference attendees that the wave of debt maturities will lead to more forced sales and boost overall deal volume as falling interest rates help make capital more accessible. 

Lonnie Hendry, head of commercial real estate at Trepp, predicted that loan origination volume would likely be between 20% and 40% higher than last year but still below 2022 levels, helped along by four or five interest rate cuts at 25 basis points each.  

“The reality is that just like interest rates rising didn't immediately stop deal flow, 25, 50 or 75 basis point rate cuts are not going to automatically turn the faucet back on full blast,” Hendry said. “But it's definitely going to be favorable for issuance relative to 2023.”  

CREFC felt much more optimistic than last year.

— Jeremy Glantz (@JeremyGlantz) January 9, 2024

Deal activity last year was also hampered by the gulf between the asking price from sellers and what buyers were willing to pay. That gap is beginning to tighten as the cost of loan extensions rises and the future economic picture becomes murkier.

Selling office buildings in this market means taking anywhere from a 40% to 70% cut on asset value, Hendry said. This kept many owners out of the market last year and made lenders more amenable to renegotiating and extending terms.  

“The challenge we have now is no lender wants to be the first lender to mass sell, and so everyone's kind of holding out to wait for someone else,” Hendry said. “Until that happens, they're going to continue to just hope that the market recovers and that people go back to work.”

The hold-on-for-better-days mentality is beginning to give way in the office sector, with several properties trading at significant discounts in recent weeks. 

The largest recent markdown came when a Morgan Stanley entity sold the leasehold interest for a 12-story Chicago office building for just $4M last week, a nearly 90% drop from its appraised value when it last sold in 2012. 

Morgan Stanley had picked up the 240K SF asset in 2021 as part of a deed-in-lieu-of-foreclosure. The investment bank had provided the previous owner, Pennsylvania-based Alliance HP, a $25M loan on the property that it then packaged and sold to CMBS investors. 

In Bethesda, Maryland, a 335K office property sold in January for just under $30M, a 22% cut from when it was acquired by Stonebridge and Rockwood Capital in 2019. The seller had embarked on a $21M renovation at the property last year but lost its anchor tenant, Clark Construction, which occupied 120K SF. 

The property had been underwritten with a loan from Wells Fargo, but the buyer, South Florida-based In-Rel Properties, obtained a new loan from EagleBank to finance the deal. 

Even in South Florida, which has continued to see a strong office market despite a slowdown in leasing volume, a 141K SF Doral office building recently traded for $28.5M, a 30% discount on its purchase price in 2019. 

“Borrowers across asset classes are trying to hold on as long as possible with the expectation that we're going to see some sort of rate reduction in 2024 that's going to make this feasible for them,” said David Szeker, partner at Kasowitz Benson Torres. “From the lender's perspective, they're looking at the environment and they're saying, ‘For us to stick around for a year in the hopes that this is going to resolve itself is too much of a stretch.’”

There is still some appetite among lenders for flexibility at the top of the office market, with performing assets still able to access capital and secure extensions. However, many are exploring nontraditional lending tools to bridge financing gaps. 

Laura Rapaport, CEO of North Bridge, said she’s been getting more calls from asset owners looking to secure the Commercial Property Assessed Clean Energy loans provided through her firm. 

The loans, which are designed to facilitate energy and water efficiency improvements at new and existing properties, had been frequently overlooked as an option when debt was cheaper and more accessible, she said. 

A wide range of energy-efficient solutions are covered under the C-PACE structure, which can also provide equity up to three years after improvements have been installed or a new project has been built, and owners are increasingly looking to use the funds to fill holes in their capital stack, she said.

“We're seeing a lot of bridge lending, and this is a partial solution to get through this next three-to-five-year period,” Rapaport said. 

Owners are also frequently having to put up more of their own capital or bring in partners to reduce overall leverage when looking for debt in today’s environment, said Lisa Pendergast, executive director of CREFC. Last year, RXR Realty modified the $1.2B loan on its 1.8M SF tower at 1285 Sixth Ave. by putting up an additional $220M of equity.

It’s become less viable to simply extend maturity dates on office assets, she said, and securing adjustments on terms requires the owner and lender to agree that “there’s life in the asset.” 

“If you're some 1979-built office property and not a lot of money has been put in the building, I think there'll be a lot of owners who will just hand back the keys,” Pendergast said. 

Conference attendees who spoke to Bisnow were decidedly more positive about the performance of non-office assets. 

Phillips, the former Treasury official, said interest rate reductions will provide some relief to the multifamily sector, which has been contending with compressed net operating incomes in the face of rising costs across the board. 

The U.S. is still undersupplied on new housing even though a wave of deliveries has eroded rent growth, but the combined $140B lending cap for Fannie Mae and Freddie Mac is only $10B below the government-sponsored entities’ watermark in 2023 and will continue to provide liquidity in the market, he said. 

“I view it as an opportunity because I think it will recover the quickest,” Phillips said. “But I still think there'll be some pain.” 

Hendry said he’s seen the spread between asking and sale price become tighter in recent months in both the multifamily and industrial space, but the hospitality and retail sectors have continued to outperform the other asset classes. 

“If we were just looking at retail on the whole, people would be overjoyed at how strong retail has been,” he said. 

Deal-makers will continue to focus on interest rate movements this year, Hendry said, but he cautioned that there weren’t any tools the Fed had at its disposal to quell volatility in the office sector. 

“Some of the systemic challenges that you're seeing across the office sector, those are not going to be fixed with 50- or 75-basis-point rate decreases,” he said.