Following the Federal Reserve’s announced quarter-point rate hike on Sept. 16 — and the potential for more increases in the future — Wall Street began fretting anew over what the higher rates will mean for the mountain of debt that will need to be refinanced in the next few years.
Jeff Sica, president of Circle Squared Alternative Investments in Morristown, N.J., was quoted by the digital platform 24/7 Wall St. as saying there was a proverbial “primal scream from commercial real estate,” following the Fed’s first rate increase in three years.
The problem is that rising interest rates are placing increasing refinancing pressure on commercial real estate. Trillions of dollars in commercial loans are expected to be coming due during the next decade, and the interest rate landscape has changed considerably from when most of those loans were taken out either just before or in the early days of the COVID-19 pandemic.
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Sica’s “primal scream” comment referred to the pain commercial landlords will likely feel as they try to negotiate refinancing terms for those maturing loans. He told 24/7 Wall St. that the difference in cost between a loan at 4% interest and a loan at 7% interest can be $600,000 per year. He didn’t name a specific project in the example.
Multifamily maturities
The Wall Street Journal reports that the hardest-hit sector appears to be multifamily developments. That sector expanded quickly during and after the pandemic but is now facing maturing loans worth about $1.8 trillion in the coming years.
The Mortgage Bankers Association estimates that between now and 2028, about $757 billion in loans are coming due, the most of any commercial sector. About $300 billion in loans are maturing this year, while another $223 billion will be due in 2027.
The office sector is also facing extensive problems concerning maturing loans, with nearly $290 billion in loans that have recently matured or are due to mature by 2028. While multifamily properties have generally held their value, office high-rises have not, with buildings facing major price discounts.
Those loans will be difficult to refinance. Apartment landlords took out many of their loans in 2020 and 2021 when interest rates were around 3%. Of course, the banks and financial institutions that made those loans have much to lose, as well. Both property owners and banks have tended to work together to extend some loans that have reached maturity, or have refinanced by bringing fresh equity to the deal.
Commercial properties in a better place
According to Cushman & Wakefield, commercial rates are expected to push above 6.5% in the near term. But the global real estate company was measured in its response, stating that the Fed’s move on interest rates was expected, so it was “pre-priced” into the market. The bigger news is there may be more increases in the future, depending on the economy and general inflation.
Cushman & Wakefield also writes that the CRE sector is in a better financial place than one or two years ago and can withstand the rate increases. Leasing has strengthened, rent growth remains firm and net operating income growth is being seen in various property types.
“The key question for CRE is whether healthy property fundamentals can continue to offset higher financing costs” Cushman & Wakefield observed in a research brief. “Encouragingly, this rate hike lands on a market with improving leasing activity, constrained new supply and broader [net operating income] growth. CRE is therefore in a better position to absorb higher rates than in was a year or two ago.”
GlobeSt.com notes that commercial real estate investors will have to be more selective moving forward.
“For investors, the question is no longer simply whether rates are high,” writes Erika Morphy, managing editor at the CRE news and analysis outlet. “It is which properties can support today’s cost of capital, which borrowers can bridge a refinance gap and which deals can still produce acceptable returns without relying on lower rates to arrive quickly. The answer will vary sharply by asset, market and capital structure.”
