Chesterfield Towne Center and its troubled loan

Office property owners and their lenders are singing verses from Bon Jovi’s “Livin’ on Prayer” these days as national headlines continue to highlight the demise of office leasing as we know it. Although there is a kernel of truth to the headlines, not all markets are suffering the blows that San Francisco and Washington, D.C., seemingly face.

According to Trepp Inc., a commercial real estate data analytics firm, there was a significant jump in May to 6.43% of CMBS (commercial mortgage-backed securities) loans backed by office properties in special servicing. That means those loans are at risk of default or will need to be restructured. The same data indicated 1.91% of CMBS loans backed by office buildings are over 60 days delinquent. To put that in perspective, 11.01% of CMBS retail loans are in special servicing and 4.90% are over 60 days delinquent.

In other words, the reality is far worse for retail-backed loans than office-backed loans.

Nonetheless, there are real problems in the world of office property ownership and lending . The noise related to the headlines is making it difficult for lenders to get comfortable with office-backed loans, and virtually no properties are trading hands. That combination makes it hard to refinance maturing loans, and it is making office owners question whether they should fund tenant improvements and leasing commissions on office buildings that arguably are not worth the loan balance.

Because owners don’t want to throw good money after bad, they are sometimes faced with the difficult task of addressing a problem a lender would prefer to ignore until the loan matures. The upshot is, some lenders are selling performing office loans in hopes of avoiding an inevitable clash with their borrower.

Office loans are not the only problem. According to an analysis by Trepp Inc., the higher rate environment is making it difficult for many maturing loans to meet the standard 1.25 X debt service coverage ratio (DSCR) test. According to the analysis, which makes various assumptions about rates and amortization, over 30% of the $58.8 billion of CMBS loans that mature in the next 18 months can’t meet the minimum DSCR test at currently offered rates.

The potential for “cash in” refinances is high, and that has led to a plethora of mezzanine and preferred equity lenders offering rescue capital. The leverage and rates offered are not terribly attractive to most owners, but it might be the only source of capital for some.

According to the latest John B. Levy Commercial Mortgage Survey, five- and 10-year loans price in the 5.60% to 5.85% range for lower leverage deals. Shorter-term, floating-rate transactions are pricing higher and are in the 6.75% to 7.50% range from banks and even higher for non-banks. CMBS loans are currently available in the 6.50% to 6.75% range.

The plight of the Chesterfield Towne Center loan is typical of what many office and mall owners are facing. According to data from CoStar, current net operating income at the property is strong with close to $13 million reported for 2022. Unfortunately, the borrower, an entity tied to Brookfield Asset Management, was unable to refinance the $90.7 million loan when it matured in October 2022 because the valuation came in at $101 million. That is a fall of 40.7% in value since the last appraisal was completed in 2012. The current valuation, which reflects close to a 13% cap rate, makes the loan-to-value ratio approximately 90%. The loan is listed as performing past maturity by the servicer, which is indicative of a loan that can get paid currently but cannot get refinanced.