Today, the commercial real estate (CRE) market is experiencing volatility across all asset classes due to higher interest rates, lower property valuations, and low economic growth, amid other factors. Aspects such as these have contributed to the market’s unpredictability and have created risks for commercial real estate borrowers. In turn, borrowers are more strategically assessing their next move as their loan’s maturity approaches.
As borrowers consider their next steps, there are some factors that they must consider such as interest rates, cap rates, and property valuations. As you evaluate your options, one question to ask yourself is, “Can I refinance my asset when my current debt matures?”. Ultimately, the answer to this question depends on aspects including market conditions, current property performance, and a borrower’s access to additional equity if necessary.
Read ahead as we explore the options of selling versus refinancing your loan in today’s market.
Market Factors Impacting CRE Loan Maturities
Over the next two years, nearly $1.5 trillion of CRE debt is due for repayment. Borrowers will be facing a vastly different financial landscape when trying to refinance this debt. With the Fed’s tightening monetary policy over the past two years, interest rates in the market place have more than doubled. Although the Fed has paused raising rates over the past few quarters (the last hike being July 2023), there isn’t a consensus in the market on when rates will drop.
Borrowers in floating rate loans have been paying incrementally higher interest payments eroding cash flow. This economic pressure on their investment, combined with lower rent growth and higher operating expenses have put owners in weak financial positions as they approach their loan maturity.
Determining Between Sell and Refi Scenarios
Selling
When opting to sell, some borrowers are in a predicament where they may not actually want to sell their properties. However, they may also not have enough cash to continue operating the property. Many borrowers purchased their property five to seven years ago with expectations that the market would continue to trend upward and financing would remain cheap. With property valuations dropping considerably since acquisition, owners must now consider selling at a loss or with very little return on their original investment. Or, they must contribute more equity to cover the gap between the current property valuation and their original estimates to navigate their loan maturity.
Simply put, borrowers aren’t necessarily selling because it’s a good time to sell. Instead, some borrowers are opting to sell because it’s the best option to minimize losses in the current market.
Refinancing
Inversely to the selling scenario, many borrowers are in a position where they want to refinance their loans. However, in a CRE market where interest rates have doubled over the past two years, refinancing maturing loans may not be possible without significant equity contribution from the owner.
Without access to additional equity to supplement their investment, some borrowers are requesting their lenders extend the current terms and rate of the loan for another 12-24 months. In hopes that the market improves, extended loan terms would allow them to refinance with a new loan and more favorable rates. Because the lenders don’t want to default on the loan (and thus have to repossess the property), they’re attempting to work with borrowers to find alternative options to ensure the property is operated effectively until the market improves. Lenders are likely to collaborate with borrowers to extend loan terms and defer potential issues until rates become more favorable. Although a “push the can down the road” solution, this alternative is a win/win for both parties.
Understanding the Calculations Needed to Determine Whether to Sell or Refi
When determining whether to sell or refinance a maturing loan, calculating the potential outcomes of each scenario can help borrowers make the most profitable decision. You’ll want to optimize your property valuation as well as analyze the cost of capital.
Calculation #1: Property Valuation
Because of current market conditions, banks are focusing on property valuations differently than they would have two years ago. Therefore, before refinancing a commercial property, borrowers should assess both current market conditions and property values to understand their current position. A strong focus on optimizing net operating income (NOI) to increase overall property valuations (NOI / cap rate) as much as possible will help increase financing options.
The performance of the local CRE market, rental rates, occupancy rates, and property demand can impact the feasibility and terms of refinancing. Conducting a thorough analysis and obtaining a professional property appraisal can provide valuable insights into the property’s value and market potential. By understanding market dynamics, borrowers can make informed decisions and negotiate favorable refinancing terms.
Note: STATVAL provides multifamily stakeholders insights into asset performance to support situational awareness and informed, swift, strategic decision-making. Contact us to learn how our multidisciplinary team can work with you to provide powerful portfolio analytics and benchmarking with time and cost efficiency.
Calculation #2: Cost of Capital
Today, the cost of getting capital from a bank is significantly higher than in the past. The cost of capital increase is the result of high interest rates and lower leverage offered from the lenders. Before you’re granted a loan, the bank will review several metrics to determine the credit worthiness of the investment. Debt-service coverage ratio (DSCR=NOI/Total Debt Service), Debt Yield (NOI/Loan Amount), and Loan to Value (LTV=Loan Amount/Asset Valuation) help determine if the asset will generate sufficient cashflow to cover the required debt payments.
How Thirty Capital Financial Can Help Borrowers Determine Whether to Sell or Refi
Thirty Capital Financial helps borrowers optimize property performance to raise and maximize their NOI. We help borrowers review their property valuations and examine projected market rates, using our forward curve analysis. With this forward curve analysis, borrowers receive a more complete picture of current and projected market conditions.
Additionally, we help borrowers look for future trends to determine the ideal time to transact. With this information, borrowers can determine the optimal time frame to refinance their loan or sell their asset to maximize returns.
Contact our team today for a conversation about your selling and refinancing options!
