From Bad To Worse: Bank Failures Thin The Ice Under Expiring Office Loans

Concern is mounting over the fate of looming office maturities as the fallout of the banking crisis adds pressure to an already-precarious lending environment.

Commercial loans set to expire in 2023 total around $400B, and office assets serve as collateral for a quarter of those loans, according to new data from MSCI. At the close of 2022, the value of office properties flagged as having a higher probability of distress already totaled nearly $40B, outpacing any other asset class.

The collapse of Signature Bank and Silicon Valley Bank, along with the near-failure of First Republic Bank, have put owners at the end of their loan terms in an increasingly perilous position, with some economists now predicting this latest monkey wrench will lead to more defaults and foreclosures.

“A lot of conservatism has already been built in — how much further it will need to go is unclear at this point,” said Kevin Fagan, senior director and head of commercial real estate economic analysis at Moody’s Analytics. “What is clear is that loans maturing over the next couple of years that were already in trouble … might be more questionable now.”

Liquidity for commercial projects — and office, in particular — has been hard to come by for a while now. Transaction volume for office deals was down 66% year-over-year in February, MSCI data shows, as rising interest rates and declining values prompted a tightening of lending standards.

Then came the bank failures, which triggered widespread anxiety over potential contagion and caused deposit outflows to soar, especially among regional banks, which have served as the primary source of CRE lending in recent months as larger counterparts go pencils-down.

This further depleted the scant money those banks have to loan, which should make refinancing, especially for office, all the more challenging, said Lance Patterson, CEO of Atlanta-based Patterson Real Estate Advisory Group. 

“If I walk into a bank and want to make a commercial real estate loan — which was already hard to do way before last week — now there’s another reason to make it even harder,” he said. “The only way they can fund loans is with deposits.”

The Federal Reserve signaled Wednesday it could be at the beginning of the end of a series of rate hikes, but lending conditions will likely get worse before they get better. Ultimately, the reason banks are expected to tighten lending standards isn't because of the high-profile bank runs from mid-March but because of what initially sparked them. 

“These two failures shouldn’t really, in a macro sense, remove a ton of liquidity,” said Rebecca Rockey, head of economic analysis and forecasting in the global research department at Cushman & Wakefield. “It’s more the panic, the unknown about other banks and the loss of confidence that is constraining liquidity.” 

A dramatic pullback in office lending is nothing new, but the bank failures don’t help, Fagan said. Borrowers looking to refinance will likely face higher capital costs, a shrinking pool of available lenders and more conservative loan terms, forcing some to throw in the towel.

“The uncertainty, the ability to get new debt and the cost of equity, if you have to recapitalize, is going to preclude some owners from being able to continue to hold onto the assets,” Fagan said. “They’re not going to bet on the future of that asset from their cost basis anymore — a new owner will have to get a new cost basis.”

The banking crisis exacerbated liquidity issues, though that doesn’t necessarily mean lenders will rush to foreclose on loans, said Varuna Bhattacharyya, a commercial real estate finance lawyer and partner at New York-based Bryan Cave Leighton Paisner. 

Some may opt to kick the can down the road, she said, offering loan extensions that include higher rates and equity requirements.

“Any type of foreclosure or pursuing of remedies is going to be expensive, and it’s going to be time-consuming,” she said. “It’s not the easiest avenue, and it affects a bank’s portfolio. If you can extend the loan and have the borrower put in more equity in the hopes that at some point there will be more financing sources or they will have the ability to pay off the loan, that’s obviously preferred.”

Whether lenders choose to work with a borrower to extend a loan will likely be based on performance, said Debra Morgan, managing director in the restructuring and dispute resolution practice at CohnReznick. 

“I don't think it makes sense to take a relatively stable office building and foreclose it for sport,” Morgan said. “It’s much more valuable to leave the real estate in the hands of owners and operators and give them the rope to work through this environment.” 

The banking crisis may also lead to an uptick in voluntary foreclosures, a phenomenon Morgan described as “jingle mail.” 

After months of funneling money into distressed assets, owners facing a dearth of available debt may choose to send the keys back to the bank — a phenomenon unfolding across several major metros.

“You’re seeing some of the biggest landlords in the country default on their loans on purpose because they know they can’t make the economics work anymore,” Bill Baumgardner, executive vice president at VanTrust Real Estate in Dallas, said during a Bisnow event Thursday. “It’ll just continue to go in that direction.” 

In late February, Columbia Property Trust defaulted on a $1.7B loan backing a seven-building office portfolio across four states. Brookfield, a major office landlord in Los Angeles, also defaulted on $784M worth of loans linked to two of its downtown office towers.

A large swath of near-term office maturities is concentrated in the commercial mortgage-backed securities universe, and close to $20B worth of CMBS loans set to come due before 2025 are classified as challenged for refinancing, according to a new report by Moody’s Investors Service. That is a relatively small piece of the overall loan pie, Fagan said, which means federal intervention is unlikely.

“It’s not insignificant, and we’re very likely to see delinquencies go up over the course of this year and next,” Fagan said. “I don’t expect to see any sort of bailout, but we will see some trouble come through.”

In a bid to clear their balance sheets of CRE debt, bank lenders may sell existing mortgages to the securitized market, shaking loose some liquidity that could ease the CMBS refinancing environment, said Lisa Pendergast, executive director of the Commercial Real Estate Finance Council. 

Already, some banks have moved to offload commercial mortgages. Renasant Bank filed a notice of foreclosure on an $11.9M loan attached to a two-story office building in the Atlanta area. In New York City, the owner of a nearly finished boutique office project said he was forced into bankruptcy court after his lender, Cecora Investment Advisors, initiated foreclosure proceedings, according to The Real Deal.

Most lenders already perceived office as carrying high credit risk, Rockey said, which means factors that existed prior to the bank failures will continue to constrain capital for new loans.

“For banks to take on an office asset is extremely capital-intensive,” she said. “When I think about how our outlook for office refinancing has changed over the last two weeks, it’s very marginal. I don’t think this really fundamentally shifts anything.”