Authored by Raymond Hu, Senior Investment Director – Head of Real Estate Credit
May 2, 2023
Commercial real estate debt maturities are anticipated to exceed $162 billion in 2023.
While this isn’t a problem in itself, it can create challenges for both borrowers, as they seek to refinance in a high-interest-rate, uncertain environment, and lenders, as the current market’s lower cash returns and higher operational costs result in an increase in non-performing loans.
Non-performing loans mean that borrowers are behind in payments or have stopped those payments—also known as distressed debt. Additionally, many economists are still anticipating a recession/economic downturn near the end of this year. These factors might spell trouble for the banks, especially when examining both distressed debt and its impact on loan-to-deposit ratios.
In other words, even as banks continue to pull back on lending, they’re facing the potential of distressed debt maturities. One solution to reduce the problems this could cause is to offload debt, especially non-performing loans, to alternative lenders including private debt strategies.
Why Maturity Might Be a Problem
A loan’s maturity date is when a borrower’s final loan payment comes due. Assuming all repayment terms are met, the debt goes away. The borrower is free from payments, and the bank has all the money it lent.
This occurs in a perfect world—but currently, many assets are experiencing distress, from office properties struggling to position themselves in a post-COVID environment to apartment buildings unable to realize the appreciation initially expected. As non-performing loans mature, they increase a bank’s loan-to-deposit ratios. It also means less available liquidity for new loans, as issuance of new loans could violate regulated capital requirements. Fewer loans could put the brakes on an industry that is already expected to remain slow for the next several months.
Added to all of this is the potential for an economic downturn. The general rule of thumb is that loan defaults increase during recessions, as borrowers lack the capital to pay debt.
How This Creates Opportunity for Private Debt
Traditional bank lenders underwrite loan amounts based on their available capital and lending parameters. This capital comes from individuals and businesses who open and put money into accounts. By law, banks must keep a strict loan-to-capital ratio intact.
Private debt operates differently. These strategies house investors who seek higher rates of return than what a traditional savings account or certificate of deposit offers and institutions or quasi-institutions that seeks appropriate risk-adjusted returns via debt investment vehicles.
These strategies then take this capital to originate loans. Some private debt strategies provide bridge loans, mezzanine debt, B-Note, and preferred equity for value-add acquisitions, refinancings or recapitalizations, conversions, renovations, lease-up or upcoming rollover, and other special situations.
In some cases, performing and non-performing debt may be acquired from other lenders. This should only done through the careful consideration of opportunities to purchase these types of loans at a discount. The intent would be to acquire the debt and improve the loan performance.
With approximately 30 years of real estate experience, our team acts as a strategic partner to help these assets, create value, and position them to benefit from the market’s eventual recovery—which could generate higher returns for our investors.
Our Outlook
There’s no doubt that traditional bank lenders will face billions in debt maturity this year. While it is uncertain how much of that will consist of non-performing loans, we do anticipate that economic volatility will likely be the norm through most of 2023.
These are positive fundamentals for loan-purchasing private debt. In fact, off-loading poor-performing or non-performing debt accomplishes two things.
First, it helps the traditional bank lender reduce its overall debt, while keeping its lending requirements intact. This means lenders have more liquidity to underwrite new loans (or to refinance others).
Second, this process helps generate risk-adjusted returns for investors when opportunities for value are identified. It can also free up traditional lenders’ liquidity, so they can issue more debt to help other real estate projects.
The takeaway is that an economic downturn and upcoming distressed debt maturity could be problematic for traditional lenders. But private lenders are equipped with discretionary and principled capital and resources to identify potential in certain distressed opportunities, which could help keep liquidity flowing by helping banks reduce the debt on their balance sheets, while maintaining strong capital pools.
For questions or comments, contact our general information department at info@kimc.com.
