This is creating opportunities for enterprising private credit firms, but the scale of the problem is truly gargantuan.

“Banks have all but left the commercial real estate finance arena right now,” one head of commercial real estate told 9fin. “Frankly, the banking void is so much larger than the alternative lending space can possibly backfill.”

Bricks in the wall

The US real estate market faces a $1.2trn maturity wall in 2024 and 2025; globally, that number is closer to $2trn. That would be intimidating at the best of times, but the retreat of banks makes it even more so. 

Direct lenders are bracing to take advantage of distressed opportunities, but even this fast-growing market can’t handle them all.

Real estate capital stacks are relatively simple, but the amount of debt in them can vary wildly. Core real estate assets (defined as stabilized, income-producing properties) generally have smaller debt loads, with LTVs of around 30%-40%.

Non-core real estate (properties that require capital investment) generally carry more debt, with LTVs sometimes up to 80% at the time of purchase. This often means smaller equity cushions for lenders than can be found in senior lending to companies as opposed to properties. 

If things go awry for non-core assets, there is not much of a safety net. Valuations have been falling due to the interest rate environment and changing demand patterns, especially since the pandemic.

MSCI Real Assets studied a sample of $2.77trn of loans in its database and found that over 80% of those loans have seen properties underlying them decline in value in the last 12 months, pushing up LTV ratios across the market.

From A to B

The pain in 2024 is likely to come from the most obvious source: office buildings. This overall situation has been well documented, but the cold reality of the numbers paints a somehow bleaker picture.

Currently, eight out of ten office loans in the market have LTVs above 60%, according to MSCI. Three out of ten have LTVs above 80%. The higher the LTV, the bigger the refinancing challenge (obviously).

A reckoning is coming. As Rich Byrne, president of Benefit Street Partners, said on our Cloud 9fin podcast in November, offices that don’t have alternative uses (especially in non-major cities) may end up trading at land value, or even below that to cover rebuilding or demolition costs.

How can owners face up to this harsh reality? 

One real estate debt and equity executive told 9fin they have seen creative restructurings of office capital structures by lenders looking to avoid mass foreclosures, in the form of so-called AB loans.

To avoid a deal going belly up, lenders are essentially being forced to split existing loans into A and B tranches, with any new equity being placed between the separated tranches. That equity will have to generate a certain return target before any value flows to the B loan.

The executive estimated that 80% of office capital structures are upside down (i.e. more debt than equity). This leaves lenders with a limited menu of options.

“You can sell your loan for 40 or 50 cents on the dollar and get out,” the executive said. “Or you foreclose on that property.”