{"id":146969,"date":"2023-02-17T14:56:29","date_gmt":"2023-02-17T21:56:29","guid":{"rendered":"https:\/\/www.biggerpockets.com\/blog\/?p=146969"},"modified":"2024-02-27T08:54:41","modified_gmt":"2024-02-27T15:54:41","slug":"commericial-debt-could-be-devastating","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/commericial-debt-could-be-devastating","title":{"rendered":"Mounting Commercial Real Estate Debt Has The Potential To Destroy Portfolios\u2014Here&#8217;s What You Need To Know"},"content":{"rendered":"\n\n      <iframe loading=\"lazy\" frameborder=\"0\" height=\"200\" scrolling=\"no\" src=\"https:\/\/playlist.megaphone.fm\/?e=BIGPOC5979390800\" width=\"100%\"><\/iframe>\r\n  \n\n\n\n\n<p><span data-preserver-spaces=\"true\">Are you tracking the storm brewing in the commercial real estate realm?&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">It\u2019s not a big surprise. It happens in every downturn in one form or another. But investors always seem to be surprised.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Though this downturn will likely not be as devastating as the Great Recession, there is one element that makes the problem more pervasive. That is the fact that a much higher percentage of the investor population invests in commercial real estate now compared to 2008.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Crowdfunding, social media, the JOBS Act, and the proliferation of new gurus (I call them \u201cNewrus\u201d) have contributed to the size of cracks in the ice that have already formed and are about to give way.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">BiggerPockets has facilitated a wonderful community that has spawned education, connections, mentoring, and so much more. Communities like ours have also created paths for investors and syndicators to connect at a level investment sponsors and investors could have only dreamed about in years past.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">And most of these investors have enjoyed wonderful returns over these past several years. The rising tide has lifted almost every boat.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">But with this wonderful return comes a good bit of risk. The concern regards newer syndicators who haven\u2019t seen a downturn taking undue risks since they haven\u2019t experienced the pain of where these risks can lead.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">What risk am I referring to here?&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">I\u2019m talking about the mountain of commercial real estate debt that will not be able to be refinanced in the coming year due to higher interest rates.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">How Will This Impact You?<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">Do you know if and how this will impact your investments?&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">In&nbsp;<a href=\"http:\/\/fitchratings.com\/research\/structured-finance\/majority-of-maturing-us-cmbs-conduit-loans-can-refinance-03-11-2022(opens in a new tab)\" target=\"_blank\" rel=\"noreferrer noopener\">this troubling report<\/a>, Fitch Ratings claims that about 23% of CMBS debt maturing by year-end 2023 will not be refinanceable under any realistic scenario. That\u2019s $6.2 billion in CMBS debt alone. This doesn\u2019t take into account agency debt and other types of private commercial real estate debt, which could be much larger.&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Three dreadful options<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">According to the Fitch Ratings report, this leaves many syndicators with three unpleasant choices to move forward:&nbsp;<\/span><\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li><strong><span data-preserver-spaces=\"true\">Raise Net Operating Income<\/span><\/strong><span data-preserver-spaces=\"true\">&nbsp;by 50% from the time of acquisition to debt maturity.&nbsp;<\/span><\/li>\n\n\n\n<li><strong><span data-preserver-spaces=\"true\">Authorize a Capital Call<\/span><\/strong><span data-preserver-spaces=\"true\">&nbsp;to deleverage these assets.&nbsp;<\/span><\/li>\n\n\n\n<li><strong><span data-preserver-spaces=\"true\">Hand the keys back<\/span><\/strong><span data-preserver-spaces=\"true\">&nbsp;to the lender.&nbsp;<\/span><\/li>\n<\/ol>\n\n\n\n<p><strong><span data-preserver-spaces=\"true\">Option one&nbsp;<\/span><\/strong><span data-preserver-spaces=\"true\">is possible but unlikely in the coming year, according to recent flatter rent growth forecasts. Origin Investments claims to have outstanding data on this front, and they project virtually flat rents in many markets in 2023. Brian Burke,&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/forums\/432\/topics\/1081276-is-a-20-25-crash-in-multifamily-asset-values-realistic?highlight_post=6185110&amp;page=1#p6185110\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">commenting on a recent Scott Trench post<\/span><\/a><span data-preserver-spaces=\"true\">, said that new rent growth projections show a significant slowdown for next year.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">This is not an option most good investors should count on, anyway.&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/a-dire-warning-for-real-estate-investors-dont-trust-the-market\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">We\u2019ve often warned<\/span><\/a><span data-preserver-spaces=\"true\">&nbsp;about trusting the market for your returns. It\u2019s not smart.&nbsp;<\/span><\/p>\n\n\n\n<p><strong><span data-preserver-spaces=\"true\">Option two<\/span><\/strong><span data-preserver-spaces=\"true\">&nbsp;asks unhappy investors to pump more cash into a sinking ship. This would water down current investor equity stakes and could even cause current investors to lose their equity as new investors demand a higher position on the totem pole.&nbsp;<\/span><\/p>\n\n\n\n<p><strong><span data-preserver-spaces=\"true\">Option three<\/span><\/strong><span data-preserver-spaces=\"true\">&nbsp;is obviously devastating. Sadly, this is already in process for many unsuspecting investors right now.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">A syndicator friend of mine was in his lender\u2019s office last month, and the banker showed him a thick manila folder of&nbsp;<\/span><em><span data-preserver-spaces=\"true\">currently performing loans<\/span><\/em><span data-preserver-spaces=\"true\">&nbsp;that the bank has already decided they would not refinance next year. These deals are too risky, given the unstable economic environment.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">This seems unthinkable, but for you who were around during the Great Recession, you know it is a sad reality. And many syndicators don\u2019t even know what\u2019s about to hit them.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">I warned about this situation in a&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/ticking-time-bomb-in-real-estate-is-this\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">recent article<\/span><\/a><span data-preserver-spaces=\"true\">, and I\u2019ve been hoping my prediction was wrong. But I fear I was right. I don\u2019t say this to ruin your day, but to warn you that the current performance doesn\u2019t mean everything is okay behind the scenes.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Now What?&nbsp;<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">There\u2019s really not much you can do about your past investments. But as we often discussed on the How to Lose Money<\/span><em><span data-preserver-spaces=\"true\">&nbsp;<\/span><\/em><span data-preserver-spaces=\"true\">podcast, it\u2019s important to learn from our mistakes. Not just our own\u2014but those made by others who play in our sandbox.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Lack of due diligence\u2014on operators and deals\u2014is one of the major mistakes investors make all the time. And if you believe in Mr. Buffett\u2019s most important rule of investing, you\u2019ll rank \u201csafety of principal\u201d as your top due diligence priority.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">While we usually discuss the safety of principal in terms of selecting the right asset type, I recommend you think of due diligence in a much deeper way. I urge you to carefully scrutinize the operator. This includes their team, their track record, their acquisition pipeline, and much more.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">And I recommend you look deeply at the debt structure because the devil is in the details.<\/span><strong><span data-preserver-spaces=\"true\">&nbsp;<\/span><\/strong><span data-preserver-spaces=\"true\">Model out the implications of short vs. long-term debt, LTC, LTV, DSCR, fixed vs. floating rate debt, rate caps and hedges, cross-collateralization, prepayment penalties, subscription lines of credit, interest-only periods, sharply decreasing occupancy and income, and increasing interest rates.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">I believe it&#8217;s also important to consider who the lender is, their experience with a particular asset class, and how they handled the 2008 crisis. We have walked away from quite a few operators and deals based on concerns over their debt.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">This won\u2019t guarantee your investment success. Even investing in an all-cash\/zero-debt deal won\u2019t guarantee safety of principal, profit, or investing success. Lots of great-looking deals have gone splat due to events outside anyone\u2019s control.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">But I sincerely believe that taking a conservative approach to asset choice, operator selection, and specifically, debt construction, gives you the best possible chance to succeed in an environment filled with unknowns.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Risky debt is one of the most certain ways to add outsized risk to a generally predictable real estate investment. Wherever and whenever you choose to invest, I encourage you to make operator selection and debt structure two of your non-negotiable investment criteria.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<div class=\"wp-block-columns is-layout-flex wp-container-core-columns-is-layout-9d6595d7 wp-block-columns-is-layout-flex\">\n<div class=\"wp-block-column is-layout-flow wp-block-column-is-layout-flow\" style=\"flex-basis:100%\">\n<div id=\"hero-block_62df1a82bfc88\" class=\"first:mt-0 hero-block py-4    has-background has-slate-200-background-color has-text-color has-theme-gold-color\">\n    <div\n        class=\"gap-10 lg:gap-20 flex flex-wrap lg:flex-nowrap max-w-screen-xl mx-auto px-4 relative lg:items-center \">\n\n        <div class=\"relative z-30 lg:w-2\/3 \">\n            <main class=\"py-4\">\n                \n\n<p class=\"has-theme-blue-color has-text-color has-large-font-size\"><strong>New! Updated Rental Market Data\u2013Top 100 US Markets<\/strong><\/p>\n\n\n\n<p class=\"has-text-align-left my-3 md:my-5 lg:my-8 has-slate-900-color has-text-color\" style=\"font-size:16px\">Download Dave Meyer&#8217;s latest dataset that shows median rents and annual and monthly growth rates for the largest 100 markets in the US. <\/p>\n\n\n\n<div x-data=\"frictionlessSignupForm()\" class=\"button-account-type\">\n\n  \n\n  <!-- Guest Button -->\n      <template x-if=\"!$store.wp.isMember()\">              <button x-on:click=\"$store.wp.displaySignupPrompt()\" class=\" btn-shape inline-block no-underline has-background has-theme-blue-background-color has-text-color has-white-color\">Download<\/button>\n          <\/template>  \n  <!-- Free Member Button -->\n      <template x-if=\"$store.wp.isMember() &#038;&#038; !$store.wp.isPaidMember()\">              <a href=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2023\/02\/Rent-Data-January-2023_For-DL-.xlsx\" target=\"_blank\" class=\" btn-shape inline-block no-underline has-background has-theme-blue-background-color has-text-color has-white-color\">Download<\/a>\n          <\/template>  \n  <!-- Pro Member Button -->\n      <template x-if=\"$store.wp.isPaidMember()\">      <a href=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2023\/02\/Rent-Data-January-2023_For-DL-.xlsx\" target=\"_blank\" class=\" btn-shape inline-block no-underline has-background has-theme-blue-background-color has-text-color has-white-color\">Download<\/a>\n    <\/template>  \n  <!-- Frictionless Popup -->\n  <\/div>\n\n            <\/main>\n        <\/div>\n\n                <div class=\"lg:w-1\/3 first:mt-0 relative h-full lg:flex lg:items-center\">\n            <img decoding=\"async\" class=\"object-cover w-full relative z-20 my-0  shadow-xl rounded-md hidden lg:block\" src=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2022\/12\/State-of-REI.png\" alt=\"\" title=\"\">\n        <\/div>\n            <\/div>\n<\/div><\/div>\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p>Are you tracking the storm brewing in the commercial real estate realm?&nbsp; It\u2019s not a big surprise. It happens in every downturn in one form or another. But investors always [&hellip;]<\/p>\n","protected":false},"author":214608,"featured_media":146970,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[7383,7119,5527],"tags":[],"class_list":["post-146969","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-economics","category-biggerpockets-daily","category-commercial-real-estate-investing"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/146969","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/214608"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=146969"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/146969\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/146970"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=146969"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=146969"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=146969"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}