Maturing Debt and Refinance Risk Top Concerns in Today's Market

Mortgage financing and the ability of fund sponsors to refinance maturing debt on commercial properties in the next 12 to 18 months is the single most important concern in today’s market, according to results of a survey of more than 40 major funds released by Ernst & Young LLP.

In fact, the firm’s 2009 Market Outlook—Trends in the Real Estate Private Equity Industry is dominated by concerns over financing with three of the top five strategic priorities for 2009 identified by respondents as debt-related. In addition to refinance risk, the ability to procure acquisition financing and an overall deleveraging of fund portfolios occupied the fourth and fifth highest priorities, respectively.

“It seems that, despite the widespread infusions of capital into various lending institutions through economic stimulus programs, it appears there is still very little—if any—lending taking place in the real estate industry right now,” says Gary Koster, head of the real estate fund services practice at E&Y. “Our survey suggests that fund sponsors are not obtaining non-recourse financing on new deals.”

Another key concern for fund sponsor respondents centers on valuations. According to the survey, capitalization rates for stable income-producing commercial properties in the U.S. are expected to continue to expand this year, furthering the value declines experienced in 2008. Of the fund sponsors surveyed, 41 percent indicated that cap rates would increase by up to 100 basis points, with another 33 percent of respondents indicating that cap rates would increase by more than 100 basis points. “Two years ago, values were based on peak earnings at peak multiples in 2007,” says Koster. “Today, our survey suggests that values this year may reflect declining earnings at depressed multiples.” He adds that the decline in values to date in the commercial property sector have largely been the result of the increasing cost of capital and have been amplified by the amounts of excessive debt leverage employed. “The great concern for 2009,” he says, “is declining real estate fundamentals and their impact on net operating income.”

The survey found 92 percent believe that there will be no economic recovery in the U.S. until after 2009.