CRE’s Property Waiting Game Is Getting Harder

Commercial property owners are grappling with the reality that the anticipated interest rate cuts might not materialize.

Jordan B. & Han-Gwon Lung
May 06, 2024

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Good morning. Commercial real estate owners with floating-rate debt face higher costs to hedge their interest rate exposure. However, they are not the only ones feeling the pressure.

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interest-rate exposure

CRE’s Property Waiting Game Is Getting Harder

Commercial property owners are grappling with the reality that the anticipated interest rate cuts might not materialize. But it’s not just borrowers who are on the hook; lenders are in a tight spot, too.

A new reality: Persistently high-interest rates are challenging commercial property owners to rethink strategies; as Fed Chair Powell said last week, “Restrictive monetary policy needs more time to do its job.” Hopes for easing refinancing conditions in 2024 are diminishing amid stubborn inflation and strong economic data, shifting expectations in the real estate market.

Escalating costs: Investor expectations for the secured overnight financing rate (SOFR) have shifted significantly, now predicting it to stabilize at 4.825% by early 2025, with only two minor rate cuts anticipated this year, down from six expected in January. This change has sharply increased hedging costs for borrowers with floating-rate debt. The cost to extend an interest-rate cap on a $100M mortgage has surged from $1.3M to $2.1M, posing a new financial challenge for owners.

The cost of these caps has become a major headache for property owners

Zoom in: Lenders are also under pressure as persistent high interest rates lead to commercial real estate loans rolling over. MBA notes that $929 billion in property loans are maturing in 2024, up 41% due to extensions from 2023. Previously effective during the low-rate environment post-2008, the "extend-and-pretend" strategy now risks tying up significant capital with no imminent return to low rates. This affects not only banks, where these loans form over a fifth of portfolios but also investors in CMBS loans, who face disappointing returns as low as 3% on top-tier bonds.

Case in point: In New York, landlords like SL Green and Vornado have paid about $100M to extend a $1.08B loan for an office building, reflecting the lengths some property owners will go to avoid defaults. However, smaller owners might choose to relinquish their properties rather than invest further.

➥ THE TAKEAWAY

Big picture: Sustained high interest rates are freezing property transactions as elevated debt costs challenge buyers to meet lenders’ coverage requirements. Property owners face tough choices: either reduce prices or invest more capital into their properties to secure loan extensions. This new reality forces sellers and borrowers to navigate a constrained market with limited options.

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✍️ Editor’s Picks

Rest in peace: South Florida developer Tibor Hollo, who was influential in shaping Miami’s skyline, passed away at the age of 96. He developed the first high-rise building on Brickell Avenue.
Hit the breaks: April's lower-than-expected job growth and a slight rise in unemployment have fueled optimism for rate cuts. Nonfarm payrolls added 175,000 jobs versus an expected 240,000.
Capital gains: As home selling profits soar, an increasing number of Americans face unexpected tax bills. About 8% of 2023 home sales exceeded the $500,000 capital gains tax exemption for couples, a significant rise from 2019, CoreLogic reports.
RE stocks: According to Bloomberg, the Fed's stubborn approach to rates is expected to bolster real estate stocks. Experts forecast a 16% rally and a 15% increase for REITs in the upcoming year.
New rules: The timeline for implementing NAR’s new policies is firming. Chief Legal Officer Katie Johnson announced that the rule changes will be effective as of August 17.

🏘️ MULTIFAMILY

Boost: Tara Capital has obtained a $55.5 million loan to finance the acquisition and renovation of Park on Voss, an 810-unit garden-style community in Houston’s Westchase area.
Pay up: An appeals court ruled against Kushner Companies last week regarding a dispute from a collapsed $186 million multifamily deal initially set for February 2022.
Tax-motivated: MLG Capital acquired Lowry North in Denver for $51 million, offering tax advantages to the seller in this transaction.
High vacancy: Maximus Real Estate Partners' $1.5 billion loan for Parkmerced, a 3,221-unit housing complex in San Francisco, is being transferred to special servicing.
Tenant protection: Colorado's HB24-1098, signed into law by Governor Jared Polis on April 19, prohibits landlords from evicting tenants or denying lease renewals without cause.
Construction chaos: Leap Development has defaulted on a $10 million loan tied to a half-acre lot slated for a 127-unit housing complex in San Francisco’s South of Market area.
Innovation is greening: The sustainability drive in multifamily is fueling innovation with new technologies, impacting both luxury and affordable housing construction and design.

🏭 Industrial

Price surge: A major sale of a Genentech-owned property in California drove up the average industrial property sale price by 22% in the U.S. despite fewer transactions overall.
More space: Hillwood announced plans for a Class A speculative industrial building totaling 766,994 square feet named Alliance Westport 14, featuring direct access to key transportation routes.
Acquisition: Terreno Realty, specializing in industrial properties in key coastal areas, has expanded its portfolio by purchasing industrial assets in New York City, Northern New Jersey, San Francisco Bay Area, and Los Angeles for $364.5 million.

🏬 RETAIL

Franchise frenzy: Flynn Group has purchased 26 Applebee's franchises in Georgia and Florida from Doherty Enterprises, which will still operate 80 locations in New York and New Jersey.
Spending slowdown: Colliers' Spring 2024 Retail Report forecasts a deceleration in consumer spending for 2024, projecting slower growth than 2023.

🏢 OFFICE

Bargain buy: Honore Properties acquired a 72,000-square-foot office building at 118 South Clinton Street for $4.8 million in cash, or roughly $67 per square foot—a steep discount from the $14 million paid by the previous owner,
Canceled: Millennium Partners has scrapped its $1B plan to construct residential and office towers next to the Capitol Records Building in Hollywood, as the city has terminated the project's entitlements.
Return to office: Cousins Properties, a major Sun Belt REIT, is upbeat about the year ahead as leasing and demand for space rebound, echoing pre-pandemic trends.
Deepening losses: Hudson Pacific reported a Q1 loss of $52 million, marking a 160% increase from the $20.4 million loss recorded in the same period last year. LA landlord’s troubles compound with slow demand for film production studios.

🏨 HOSPITALITY

Montauk market: As summer nears in the Hamptons, a Montauk restaurant faces an uncertain future. The space housing Sel Rrose in the East End is up for sale at $6.3 million.
Refinancing: Hudson Bay Capital granted a $155 million loan to refinance a 725-room hotel located at 511 Lexington Avenue.

📈 CHART OF THE DAY

While there's a valid concern for specific banks, non-residential commercial real estate constitutes less than 10% of total assets at US banks. Jack Ablin, CIO at Cresset, believes potential losses can be managed without triggering a banking crisis, thanks to Fed interventions in 2023 and massive rate hikes.

Due to lengthy loan and lease terms, property challenges are expected to unfold gradually. If rates decline later this year as anticipated, values could still rebound.

Office sector risks seem concentrated in downtown areas of major cities, particularly impacting top-tier metro markets like New York. Smaller regional banks favor suburban offices, which are in better fundamental shape.