How big an impact will the US real estate refinancing wave have? The real estate mortgage market has seen two major changes over the past 18 months: a significant decline in property values and a corresponding change in the availability of loan financing. These changes have caused concern in parts of the real estate market where property values have fallen significantly and loans are approaching maturity.
How big is the problem?
At first glance, this problem seems very large. Of the US$2.77 trillion in loans in our research sample drawn from the MSCI US Mortgage Debt Intelligence database, approximately 81.5% by value (those to the left of the 0% y-axis in the chart below) are associated with properties that have experienced a decline in the MSCI traded price index over the past year. However, the past 12 months is not the most appropriate measurement period for considering the health of the loans. Only 40.4% by value (below the 0% x-axis in the chart below) have experienced a decline in the price index over the life of the loan, measured from origination through Q2 2023. This percentage is significantly smaller than the 81.5% that have recently experienced market price declines, but it is still a significant number. However, some of these declines have been relatively small movements, with only 6.6% by value experiencing a decline in the price index of 20% or more from their respective issue dates.
Despite the recent price decline, most collateral remains above water
Loan-to-value ratio and maturity also matter
The core problem investors are trying to solve is identifying which loans are potentially at risk, a question that requires an assessment of the loan-to-value ratio (LTV).[1] Taking into account the relevant maturity dates,[2] It is not merely an estimate of the collateral value.
The chart below shows loans maturing over the next 10 years that have experienced negative growth in the price index over the life of the loan. The original LTV of each loan is adjusted to account for the price growth of the relevant price index over its life. For example, if the initial LTV of an asset is 60% and the price index has fallen by 40% since the loan issuance date, the estimated current LTV would be 100%. Obviously, this approach makes the simplifying assumption of no amortization.
A high LTV means that borrowers may face difficulties when seeking to refinance, especially for loans approaching maturity. Anecdotal evidence suggests that LTVs above 60% today reduce lenders' willingness to provide debt financing capital, and we estimate that approximately US$1,227 billion, or 44.3%, of the loans in our sample have current LTVs above that level. Of this subgroup with LTVs above 60%, 58% will mature within five years and 37% within three years, which is why they deserve particular attention.
Loans with high LTV and approaching maturity dates are of greatest concern
The chart below uses the same sample to highlight potentially stressed loans from a property type perspective. It shows how the distribution of loans at a given current estimated LTV varies by property type, indicating the potential scope and severity of potential refinancing issues.
Office is particularly risky, with roughly 81.3% of office loans currently with estimated LTVs above 60% likely to have difficulty refinancing when they approach maturity. As the LTV range moves up, the distribution by property type begins to diverge significantly. At LTVs of 80% and above, a higher percentage of office loans (roughly 30%) have LTVs above that level, whereas only 15% of retail loans and about 20% of industrial and apartment loans have LTVs above that level.
A greater percentage of offices are at risk
A complex picture of risks and opportunities
While the majority of U.S. real estate mortgage collateral has been impacted by the recent price declines, a closer look at how lifetime loan price fluctuations have affected estimated LTVs paints a more nuanced picture, particularly for loans with large declines in property values, high LTV ratios, and near maturities.
The authors would like to thank Alexis Maltin for his contributions to this blog post.