Interest only loans, with balloon payments that are due normally in five years, increased in popularity in recent years. These types of loans accounted for 81% of new commercial loan activity in 2021. This was up from 51% back in 2013.
These loans became popular because they’re less expensive than normal loans that include principal and interest in the monthly payment. They normally mature in five years when a full balloon payment of principal is due.
$1.5T of these loans are coming due in the next three years. Landlords who hold these loans normally secure new financing when they come due.
The problem is that with interest rate increases, the new loans carry a significantly higher monthly payment. It’s been estimated that 35% of the loans maturing between now and the end of the year, won’t be able to be refinanced because existing rents won’t cover the new monthly payment.
Take a moment and think about the implications. What will happen if 35% of $1.5T in debt goes into foreclosure in the next three years?
Commercial property prices will drop like a rock as landlords do whatever it takes to get out of a deal. Significant numbers of banks will fail as they take back property that can’t be refinanced.
And what happens when banks take back properties and put them into their “Work Out” portfolios? They drop the prices even further to get these bad deals off of their books.
Let me leave you with this.
Any of you who’ve read me for any amount of time know that I don’t spend a lot of time on banks and lending activities. Any good accountant will tell you that the only way you’ll ever get rich in this country is to not owe a penny to a soul.
But I’ve been predicting a real estate recession for over the past year. It was inevitable and we’re at the beginning of the cycle.
First, if you’re holding any of this debt, the time to deal with it is now. If you can secure longer term financing, get it done.
If you can’t, then now might be the right time to sell some real estate. Anything you can do to not be forced into a foreclosure and the resulting personal bankruptcy if the loans are personally guaranteed should be a priority.
Second, if you’re considering purchasing real estate, be patient. Let nature take its course. Allow the prices to come down before making a purchase. Use this as the opportunity it represents.
Once the prices come down you’ll probably be forced to pay a higher interest rate than you’d like. But realize that you’ll be able to refi out of it once the rates come down again in a few years.
Most of us make money in real estate when we purchase a property, not when we sell it. If you pay too much, it may take too long for you to again get into a good position.
We’re all going to get through this. Let’s get through it together.
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