There is an unprecedented amount of senior loans coming due in 2023. According to CRED iQ, next year has the highest volume of schedule maturities for securities CRE loans over a 10-year period.
Multifamily
Here is a breakdown of the multifamily loans maturing in 2023:
Freddie Mac: $7.7 billion
CRE CLO: $7.5 billion
Fannie Mae: $7.3 billion
The CRE CLO is of particular interest because most of that is high-leverage, short-term floating rate debt. Those bridge loans will have a difficult time hitting a 1.25 DSCR with a higher than forecasted interest rate. What does this mean for next year?
Read More: How Bridge Lenders Inflated the Multifamily Market
While no one knows what is going to happen, the short-term forecast is for U.S. federal funds effective rate to remain above 4%. This in turn will put upward pressure on treasuries. While the 10-year Treasury does not always follow the federal funds rate, there might still be some upward pressure due to inflation expectations.
It will be important to watch the moves the Fed makes closely. Also pay attention to inflation and inflation expectations. If investors expect inflation to persist, then they may demand a higher yield on their investments to compensate for the erosion of purchasing power.
Higher 10-year treasury yields in 2023 will put many investors at maturity risk. Some investors might need to come up with additional equity to refinance out of a bridge loan that is below a 1.25 DSCR.
Sizing Constraints Explained
Let’s look at an example of a deal that might be at maturity risk:
| Purchase Price | $25,000,000 |
| Cap Rate | 4% |
| NOI | $1,000,000 |
| Senior Loan | $20,000,000 (80% of Purchase Price) |
| CapEx | $2,000,000 |
| Total Loan | $22,000,000 |
In this example we will assume the deal was purchased in the summer of 2020. It is a 3-year bridge loan with extension options. So, the loan is coming due in the summer of 2023 with the option to extend.
It is important to note that at the time of purchase the 10-year treasury was below 1% meaning that the interest rate for an agency loan was roughly 3%. Sizing this deal of $1,000,000 in NOI at a 3% interest rate to a 1.25 DSCR amortizing gives us $15,800,000 in loan proceeds.
Why does this matter? The original loan was barely at a 1.0 DSCR amortizing at the time of purchase. To hit a 1.25 DSCR to replace a $22,000,000 loan (assuming all CapEx is used), NOI needs to be $1,390,000. NOI needs to increase by 39% in 3 years assuming the interest rate remains at 3%.
However, the interest rate on an agency loan is now 5.5% to 6%. So even if NOI growth is strong, higher interest rates create enormous headwinds. In this example, a $22,000,000 loan sizes to a 1.25 DSCR amortizing at 5.5% if NOI is $1,870,000. That is almost having to double your net operating income.
This is just an example, but it illustrates why there is maturity risk next year. It will be interesting to see what happens and where interest rates go. At the time of this writing the 10-year treasury opened at 3.75%.
Bid-Ask Spread
The bid-ask spread is the difference between the highest price that a buyer is willing to pay for an asset (bid price) and the lowest price that a seller is willing to accept for the asset (ask price).
Due to rising interest rates, the bid-ask spread on multifamily is off. The seller’s ask price is reminiscent of a short time ago where you could get high-leverage, low-interest rate bridge debt. However, buyers are realizing that sizing to an interest rate that is 2% to 3% higher on an agency loan leaves them vulnerable.
The previous example is enough to illustrate why buyers are less likely to take on such a risk. Transaction volume will remain low if bid-ask spreads do not adjust. If interest rates do not decrease, then cap rates will expand. Sellers will not want to sell at the expanded cap rates so they will seek a solution to hold.
It is to be determined whether they can hold on or not. The forward curve on interest rates has fed funds around 5% next year and the 10-year is projected to hold or go up slightly. If this holds true, then many borrowers must bring more equity to refinance or exercise an extension if the lender allows it.
The cost of the floating rate debt is also having a significant impact. Those who bought a low strike interest rate cap might not be getting crushed with higher debt payments right now, but replacing the cap is up more than 10X.
The escrow payments to replace an interest rate cap can be as much as the debt payment itself. We could see the ask price come down a little to offload some of those pressures.
Conclusion
Loan maturity is something to watch for in 2023. Communication will be critical next year as many borrowers face difficult decisions. Communicate with the lenders on possible solutions or extensions. Also communicate with limited partners the situation at hand. One thing limited partners do not like is being left in the dark.
There will be buying opportunities next year. Not everyone will be able to cover the increased carrying costs of these deals. I suspect there will be more capital calls next year if interest rates do not go down significantly.
Hopefully there is some relief next year or some financing solutions made available. Hope for the best but prepare for a higher interest rate environment.
