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Loan Modifications Then and Now – Extend & Pretend


In the landscape of commercial real estate (CRE) financing, the practice known as "extend and pretend," where lenders extend the maturity of a loan to avoid recognizing a loss, has evolved in its implications and strategy, especially when comparing the aftermath of the Global Financial Crisis (GFC) to current market disruptions. 


This analysis dissects how the economic and market environments during these two periods have shaped the approach to commercial mortgage loan extensions, with a particular focus on the office sector.


GFC Perspective

During the GFC, the CRE market faced unprecedented challenges characterized by the "extend and pretend" phenomenon. The disruption caused by the "too big to fail" institutions was of an unparalleled scale in recent history, resulting in a severe lack of liquidity in the market. Lenders found themselves with no resale market for the properties they repossessed, leading to massive charge-offs on these assets.  


In response, the Federal Reserve aggressively cut rates to stimulate the broader economy and specifically encourage CRE transaction activity. Lenders were motivated to collaborate with borrowers who were willing to fight for their properties, as extending CRE loans into a lower interest rate environment proved beneficial. This strategy offered a lower cost of capital and lower cap rates, consequently driving up property values. 


Current Perspective

During the current landscape, the CRE sector faces a different set of challenges compared to the GFC. Over the past 18–24 months, the Federal Reserve aggressively hiked rates, yet the full ramifications have yet to be fully understood within CRE. Despite these higher interest rates, new issuance continues across all lender sources, indicating ongoing activity in the market. While loan origination volume experienced a significant decline of approximately 50% from 2022 to 2023, it did not come to a complete halt, as observed during the GFC.


However, the majority of the fixed-rate loans originated before 2022 carry interest rates in the 3–5% range, whereas current refinance rates for these loans hover between 6.5–10%, illustrating a substantial increase in the cost of capital. Higher borrowing costs, coupled with higher capitalization rates, precipitate a decline in property values, exacerbate loan-to-value ratios, and tighten debt service coverage ratio/debt yield constraints.


Additionally, the looming maturity of a significant volume of loans through 2027 across all lender sources creates a sense of urgency. The availability of sophisticated capital on the sidelines, eagerly awaiting distressed sales opportunities, adds an additional layer of complexity to the extend and pretend strategy.


State of the Office Sector 

In the context of the broader CRE challenges, the office sector is undergoing a profound transformation, unlike anything seen in generations. The shift towards remote work has become entrenched in the experience of most employees, prompting a reassessment of the intrinsic value of office assets.


Many older office buildings now face functional obsolescence, failing to meet the evolving expectations of modern workers. Moreover, the sector is burdened by over-leveraged properties, previously considered safe investments but now underwater due to decreased occupancy rates and lack of viable adaptive reuse options at scale.


According to Trepp's data, office properties that have been transferred to special servicing have experienced staggering value losses exceeding 50%.


Compounding these issues, lenders find themselves ill-prepared to absorb losses from this asset class across their portfolios, lacking adequate reserves.


Looking ahead, the office sector faces significant challenges with the maturation of CMBS loans, as $21.0 billion and $20.2 billion worth of single-property CMBS office loans are set to mature in 2024 and 2025, respectively. These impending maturities add further pressure to an already strained market, highlighting the urgency for strategic adaptation and risk management within the office sector.



Conclusion

The strategy of "extend and pretend" has undoubtedly evolved from the GFC to the current market disruptions, reflecting the changing economic landscapes, interest rate environments, and sector-specific challenges.


For the office sector, the situation is particularly precarious, given the structural shifts in work habits and property valuation criteria. Lenders and borrowers alike must navigate these turbulent waters with a keen understanding of the broader economic impacts, innovative financing solutions, and a strategic approach to asset management and loan extensions.


The journey ahead demands a delicate balance between immediate financial pressures and long-term viability, with a clear-eyed recognition of the transformed landscape of CRE financing.


Looking for more? To gain further insight into the data presented in this analysis and discover how you can access information on more than 5 million commercial properties with TreppCRE, request more information from one of our experts.


Questions or comments? Contact Trepp at info@trepp.com or 212-754-1010


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