By the Numbers
Evaluating maturity defaults in office properties
Mary Beth Fisher, PhD | March 31, 2023
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Commercial real estate loans historically tend to show defaults disproportionately around maturity. And lately the spotlight has fallen on office properties. The pandemic-induced decline in occupancy, high interest rates and a significant near-term maturity wall is intensifying stress on the sector. But identifying the risk that an office loan might default at maturity is difficult from trailing financial data alone. Several office loans this year have already defaulted at maturity due to the near-term rollover of large tenant leases, which substantially lowered net operating income and made it difficult for borrowers to either secure new financing or sell the property.
There is $27 billion of office loans, net of defeased loans, outstanding across CMBS products scheduled to mature in 2023 (Exhibit 1). Fully 6.3% of balances, or $1.8 billion, have already matured and not yet paid off. These loans are concentrated in conduit and CRE CLO deals.
Exhibit 1: Breakdown of office loans maturing in 2023
Notably, the bulk of matured but still performing loans are shorter-term, floating rate loans in CRE CLOs and SASB, while most of the maturity defaults where the loans are not performing are in conduit deals. A subset of the office conduit loans that have already matured but not paid off is shown in Exhibit 2. Many of the loans show clear deterioration in financial metrics:
- The occupancy rates from deal cutoff to most recently recorded level have declined for most loans;
- Loan-to-value (LTV) ratios have in several cases risen;
- And debt service coverage ratios (DSCR) have in many cases declined sharpy, with several dropping close to or below 1.0.
Exhibit 2: Office loans in conduit deals that have matured in 2023
Unfortunately the reported financials are not always current. Based on reported financials the Trenton Office Portfolio has increased occupancy from 94% to 96%, lowered LTV from 73% to 51%, and the debt service coverage ratio has risen from 1.74 to 1.83. However, the original maturity date of the loan was 6/6/2022. The delinquency commentary from the special servicer notes the following:
The Loan transferred to the Special Servicer due to Imminent Default related to the Loan’s upcoming maturity date. Borrower and Special Servicer executed a Modification Agreement on 9/20/2022 that extended the Loan’s maturity date to 1/6/2023. Special Servicer has negotiated an additional extension that includes the paydown of the loan with excess cash and is currently seeking approvals to complete the execution of the agreement.
Reading the delinquency and watchlist commentary is often the best way to understand the risks and potential workout options for the loan. The delinquency and watchlist commentary for the first four loans in Exhibit 2 is shown in Exhibit 3. The first two loans are listed as matured, while the second two are matured non-performing.
- The Central Park of Lisle loan, although listed as matured and putatively still performing, appears to be headed to receivership and liquidation.
- The Katy Freeway loan appears to be arranging a sale where the buyer would assume the loan, and possibly pay it off.
- Based on the watchlist commentary, in March 2022, Gateway Center was projected to lose 49 of its current tenants, who leased 9% of the space, as their leases rolled over in the next 12 months. That appears to have occurred and occupancy fell to 67% and DSCR is barely above 1.0. The loan was modified and the maturity date extended to 1/1/2024.
- The Charlotte Plaza loan also knew that two large tenants were planning to not renew their leases prior to the maturity date of the loan. Their attempts to refinance the loan ahead of the maturity date did not appear to be successful. The loan is in default and the borrower is currently in negotiations with the special servicer.
Exhibit 3: Delinquency and watchlist commentary for select conduit loans
Although these matured and modified loans are not technically included as delinquent loans in most statistics, clearly some of them are headed into workout and will likely experience losses. Using the financial data to identify deterioration in loan performance, then following up with a review of the watchlist and delinquency commentary from the special servicers is the best way to assess potential defaults as a first step.
Loans in CRE CLOs that have hit a maturity date already this year and have extension options, typically do not have substantial delinquency or watchlist commentary. The notes for most of the CRE CLO office loans whose status is “matured”, simply state “extension modification in process”. The delay in the current circumstances, with floating rates having risen dramatically since the loan was originated, is often due to a negotiation with the borrower about replacing the interest rate cap, or negotiating an alternative to buying another cap.
Like conduit loans, SASB loans tend to have extensive delinquency and watchlist commentary, and investors need to monitor it to understand the workout options being potentially pursued by the special servicer.