Bloomberg published an article – Global Real Estate is Sitting on a $175 Billion Debt Time Bomb – Bloomberg – regarding the rise in distressed real estate debt and decline in values.
The $175B in distressed real estate debt is quite striking – exceeding the combined total distressed debt of the next 9 largest distressed debt by asset types.
US real estate has declined 9% in value while UK real estate is down 20%. MSCI opines in its 2023 Trends to Watch in Real Assets – MSCI that London offices will need to decline by another 9% to be of interest to investors. But the US is lagging, not avoiding.
Of course. both distressed debt and declining values are intimately interconnected and amplified by the low cap rates and interest rates of the past.
For example, a property with $1 million net income valued at a 4.5 cap rate is $22.2 million and an 80% LTV loan would be $17.8 million. The same property at a 5.5 cap rate is valued at $18.2 million – an 18% decline in value. The loan LTV is now 98%. In short, the sponsor’s 5-10% equity and most, if not all, of the LP equity is wiped out.
Although the property could still be servicing the low interest rate debt, the minimum loan required LTV is out of balance – to which the regulators could turn a blind eye allowing the lenders to kick the can down the road – but the real distress will eventually come with the refinancing when the loan must be paid-down or deed handed over.
So, we’re entering the stage in the cycle of white knights and loan-to-own and bets on if we’re buying at a discount or catching the knife on the way down.