At the time, it had grown to 25 per cent of the commercial mortgage market, since its inception in 1997 by Merrill Lynch. The two years preceding the collapse had been active ones, with CMBS issuances totalling $3.2 billion in 2005 and $5.4 billion in 2006.
The bulk of this financing was done on 10-year terms, meaning there will be many borrowers considering their options as these mortgages mature over the next 20 months.
CMBS loans aren’t designed to offer renewal options, due to the repayment structure of the CMBS bondholders. While a renewal isn’t available, that doesn’t mean the debt markets aren’t interested in providing financing via a refinance.
The good news is the lending landscape has shifted since 2005-06, with interest rates dropping significantly. Most of these maturing loans are carrying interest rates of 5.25% – 6.25%.
Opportunities to improve debt structure
Refinancing now, or in the foreseeable future, will offer opportunities to improve the debt structure of your commercial investment. So what are the options for these properties that haven’t had to consider financing for a decade?
A new conventional mortgage is an obvious choice, as the market has an abundance of five-year terms to offer. Interest rates can vary but the best product will see a quote that starts with a two. A $5-million loan in 2006, bearing interest at 5.73%, would have a loan balance of $3,777,466 at maturity.
Refinancing this amount at three per cent would see the monthly payments reduced to $17,877, down from $31,192. The impact on cash flow is significant.
While the CMBS market did collapse in 2007, it was brought back to life in 2013. Given the scarcity of 10-year conventional money, a new CMBS loan can provide a great option to borrowers seeking longer terms. The interest rates are typically around 4.00%, although this can fluctuate with the Government of Canada bond yield.
Monthly payment would decrease substantially
In this structure, the $5M borrower would see their monthly payment decrease to $19,870 from $31,192.
In both of the scenarios discussed, it was assumed the borrower would simply refinance their outstanding balance and enjoy lower monthly payments. Refinancing now is a great opportunity to take a large amount of equity out of the property at historically low interest rates.
Assuming the original $5M loan from 2006 was established as 70% loan to value (LTV), we can extrapolate the value then was $7,142,857. Using a modest annual growth in value of three per cent, we can determine the property is now worth $9,599,402. Refinancing this property at 70% LTV would pay out the outstanding balance of $3,777,466 and give the borrower access to $2,942,115 in equity (fees not accounted for).
As a part of the refinance process, lenders will require new third-party reports. These include an environmental site assessment, a building condition assessment and an appraisal. Most owners will have typically not done this since the last time they financed their property 10 years ago.
In addition to satisfying the lender, there is value in obtaining these documents. Over the course of 10 years, environmental regulations and standards will have changed, buildings can deteriorate and the metrics of market value can shift.
Accurately forecasting today’s low interest rate environment back in 2005 would have been very difficult, so property owners can thank good fortune they have such favourable options available to them. Whichever decision is made, it will improve the performance of their asset.
Adam Powadiuk is a Business Development Manager with First National Financial, Canada’s largest non-bank lender. He is active in most markets in the country with a focus on investment real estate. All feedback is welcome and he can be reached at [email protected].