Higher Rates, Rising Costs Push More CRE Loans into Distress

This piece is adapted from an article originally published by Globe Street.  

Higher interest rates and rising costs are straining commercial real estate borrowers, and changing how they and their lenders and special servicers approach distress and workouts. Cheaper loans originated in 2021 and 2022 are scheduled to mature, representing about $875 billion in commercial and multifamily mortgages or 17% of the roughly $5 trillion outstanding.   

According to Curt Spaugh, Head of Special Servicing at SitusAMC, the math has changed. “Interest rates may have been as low as 3% and now rates are significantly higher,” said Spaugh. Refinancing now means far higher rates at a time when NOI hasn’t grown enough to offset operating costs. 

“It makes it very, very difficult to refinance those loans,” Spaugh added. He notes that early communication, a credible turnaround plan and new capital can make a difference. 

Early Action Means Options 
 
Borrowers who see trouble coming should raise it early if they hope for a favorable outcome, Spaugh said. In securitized loans, a contractual trigger such as an imminent default, maturity default or missed payments typically moves a loan to special servicing. A borrower who warns the master servicer of a potential maturity problem can give the special servicer more time to evaluate. 

“We love having the additional time that allows us to really assess the situation and order third-party reports such as brokers' opinions of values, appraisals,” Spaugh said. That additional time also lets the servicer inspect the property and meet with the borrower to understand the proposed business plan. 

Fresh Capital Is Key 

Borrowers can strengthen their position by demonstrating a credible plan and a willingness to contribute capital. That matters most when a property is underwater because servicers need to see that extra time isn’t just “stalling the inevitable,” Spaugh said. 

Special servicers have a range of potential resolutions, including extensions, forbearance agreements, loan restructurings, discounted payoffs, note sales and foreclosure.  

Property Type Impacts Resolution 

Property type also matters. Hospitality, for instance, is an operating business that requires specialized expertise. That can make a foreclosure more complicated for a servicer that doesn’t have hospitality operating capability.  

Office properties present a different challenge. They require substantial tenant-improvement and leasing-commission expenditures to attract new tenants. Multifamily and retail, by contrast, can be easier for the lender,  to take over and manage, Spaugh notes.  

CMBS Structure Can Complicate Workouts 
 
Office remains a particular source of distress, Spaugh says, with remote work still weighing on demand. In August, office had a 14.87% CMBS delinquency rate, the highest among major property types.  

CMBS structure can make workouts harder. Unlike a balance-sheet lender, a special servicer must act in the best interest of all CMBS bondholders, whose interests can conflict. First-loss holders may want an extension to buy time, while senior holders may want to liquidate an asset before values slip further. 

The bigger constraint, Spaugh said, is funding. A master servicer may have to advance funds for property taxes, tenant improvements and leasing commissions, and may balk if it fears not recouping them. A promising lease can stall, and brokers stop bringing tenants to a property that can’t deliver improvements and commissions. 

Borrowers who engage early, have a credible plan and new capital, give servicers the time and confidence to pursue a workout. 

SitusAMC’s Special Servicing solutions provides clients with a white-glove approach, offering a need-driven, collaborative and responsible engagement model. SitusAMC dedicates a highly responsive single point of contact, helping streamline client engagement and reduce operational risk. Learn more on our website or contact Curt Spaugh, Head of Special Servicing.