The Building Is Fine, the Capital Stack Is Not: Refinance Gaps, Retrades and First Moves for Owners and Lenders

Last Thursday, a major real estate broker and a major hotel brand said out loud what I have been seeing for months. If you own a building, hold a loan, or have a plan that needs money, it is worth hearing.

Robert Sulentic, chief executive of the commercial real estate services firm CBRE, told analysts that "deals that were under contract are getting retraded," meaning a deal already under contract is reopened and the price or the terms change. He said some owners are refinancing where CBRE expected them to sell. CBRE's finance chief also said the firm's property sales revenue in the United States rose 37% from a year earlier. That is fee revenue, not a count of deals, but it says buyers and sellers are still meeting. Some meet only after the price or the terms change. The same morning, Wyndham's chief executive, Geoffrey Ballotti, said transactions in Wyndham's economy and midscale segments fell more than 30%.

Neither said demand had collapsed. Wyndham's hotels in the United States grew revenue per available room, the industry's main measure of demand and price, 6% from a year earlier. In the deals I see, the pressure is coming less from the buildings than from the money behind them.

What changed

The Treasury's 10-year yield was 5.00% on Friday, and the Federal Reserve announces its interest-rate decision on Wednesday. Fixed-rate loans tend to move with the 10-year. Floating-rate loans move with the Fed.

Here is what that can do to one building. It is worth $10 million and earns $600,000 a year after operating expenses, 6% on its price. Say you bought it with a $6.5 million loan when rates were lower, and the new loan is 7%. The interest alone is $455,000 a year. What is left, $145,000, is 4.1% on the $3.5 million of your own money. With no loan, the same building pays you 6%. Each borrowed dollar now costs more than it earns. That is called negative leverage.

It also shrinks the next loan. Say your lender wants the building's income to cover the loan payment 1.25 times. The income can then cover a payment of about $480,000 a year. At 7% with a 25-year payment schedule, that payment supports a loan of about $5.66 million. The loan coming due is $6.5 million, 65% of the building's value. The price did not create the gap; the payment test did. Someone has to find about $840,000.

Every seat at the table has to deal with that gap, each in a different way. What you do about it depends on which seat you are in.

5 seats, 5 first moves

1. You own a building with a loan due in the next two years. The Mortgage Bankers Association (MBA) counted, as of the start of this year, $875 billion of commercial and multifamily mortgages scheduled to mature in 2026 and $652 billion in 2027. Many will be refinanced, extended, or paid off. Owners who start late have fewer choices. Run your refinance at today's rate and your lender's coverage test now. Then put 4 answers side by side: bring cash, sell, bring in a partner for part of the equity, or extend. An extension only helps if you know what you will do with the time.
2. You planned to sell this year. If your buyer comes back to change the price or the terms, ask what changed in their financing, not in your building. A buyer whose loan shrank wants you to cover the difference. Before you answer, compare two numbers: what you would net from a sale at the new price, and what holding is worth to you after the cash a refinance would take. That comparison sets the lowest price at which selling beats holding.
3. Your income is growing, and you still cannot get the loan you need. In the Federal Reserve's July survey of bank loan officers, more banks eased standards than tightened them on apartment loans and on loans against existing commercial buildings. Construction standards were unchanged. Lenders still weigh the income they can already see most heavily. Lead with the last 12 months of actual income, then show the evidence behind your forecast. If you need more than that income supports, consider preferred equity: a partner who is paid before you. Read what it costs before you sign, because the terms will take cash flow, some of your decisions, or both.
4. Your family has equity tied up in a building you want to keep. The building may be worth more than you paid, and a new loan still will not hand you the cash you expected. Before you sell to unlock it, price the options that keep it: a smaller first loan with a second layer of financing behind it, a preferred equity partner, or seller financing if a family member or partner is buying in. Each one costs you cash flow or control. For each option, including a sale, compare the cash you get now, the income you keep each year, and the control you keep. Then decide which you can afford to give up.
5. You are the bank, or the servicer managing the loan for its owners. Federal bank regulators wrote in their 2023 guidance on loan workouts that prudent workouts "are often in the best interest of the financial institution and the borrower." The owner across the table often knows the building better than anyone you could hire. Ask for a plan with dates and a clear source of repayment, an outside look at the operation, and a borrower who brings something new: cash, a partner, or a better operator. An extension with no plan behind it only moves the same problem to a later date.

Next week I will take the developer's seat: why a project that leases up well can still come up short when the permanent loan replaces the construction loan.

For many owners, the building is not the problem this year. The capital stack, the debt and equity behind the building, is where the work is. Which seat are you in?

-Damon

Damon C. Healey, Founder, Eternal Companies

If you own real estate and need someone to package your deals, review your investor and lender terms, or help you decide whether to grow, bring in a partner, or sell, write to me at [email protected] and tell me what is stuck.

I read every reply.

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