If a hotel borrower falls in a bank and no one is around to hear it, will it make a sound?

If a hotel borrower falls in a bank and no one is around to hear it, will it make a sound?

The long predicted tsunami is upon us. According to Trepp and the Federal Reserve, there will be roughly US$550 billion of maturing commercial real estate debt in 2011. That will be followed by an estimated US$790 billion in 2012, US$370 billion in 2013, US$260 billion in 2014 and US$220 billion in 2015. Even allowing for the fact that the 2012 number includes some one-year extensions on 2011 maturities, roughly US$2 trillion of commercial real estate debt is maturing — and in need of refinancing — over the next four years. That’s trillion — with a T. About the time that this wave is receding, the next one — comprised of 10-year paper financed during the 2006-2007 peak — will be arriving (estimated to a shade over US$200 billion in both 2016 and 2017).  

The fact that this surge of maturing debt has been predicted for several years means that my reporting of it here is not newsworthy. What was not predicted or even predictable before, however, was what the economic and financing environment would be like on or about the time it occurred. That is now clearer — and it’s not a pretty picture.  

Let’s start with the fact that the only viable source of capital in the amounts necessary to replace these maturing loans is a healthy and active CMBS market. Now ask yourself, which of the following does NOT exist at the present time? 

a) Political turmoil 
b) Economic turmoil 
c) One moon orbiting the planet earth 
d) A healthy and active CMBS market  

If you picked “d,” you are correct and should, perhaps, have a blog of your own.

So, where is all this new capital going to come from?  

Life companies are a fairly reliable source for approximately US$50 billion. CMBS originations in 2011 are expected to be less than US$40 billion. (At their peak in 2007, CMBS originations for all commercial real estate totaled US$230 billion.)

The rest must come from the banks and, to a far lesser extent, higher-priced niche players — and it is highly unlikely that they will be able to fill the hole.  

The resulting deficit, combined with the absence of regulatory pressure on lenders holding existing paper, means lenders MUST and WILL extend. What follows are some likely consequences for hotel financing during in the next couple years:

  • A great deal (the majority, in fact) of banks’ capacity will be used up extending existing loans.
  • Outside of loan extensions, there will be slim pickings. The basic tenets of supply and demand will take hold, and only the very best projects with the very best sponsors will have access to debt for the next few years.
  • Lenders, who have been emboldened by recent hotel performance statistics and improved values, will be more aggressive in their dealings with borrowers renegotiating loans. They will require both loan paydowns and higher interest rates.
  • Unless lodging fundamentals turn decidedly sour, fewer loans will be sold at discounts. 
  • Cases where a lender will negotiate a reduced principal with an existing borrower will be fewer still. 
  • Many of the newly extended higher-interest-rate loans will be in jeopardy if the economy softens — indeed, it is only because of extraordinarily low interest rates that they have managed to steer clear of monetary defaults thus far.
  • Construction financing (especially for full-service hotels) will be virtually non-existent through 2013, at least.
Despite the black cloud on lending, there is a bit of good news for hotel owners, at least in the near term: Even with dramatically widening spreads, interest rates will still be cheap by historical standards.