WASHINGTON (Dow Jones)–Owners and developers of commercial real estate will now have more flexibility to rework their mortgages or obtain loan extensions under a new federal tax rule, a change that could aid the troubled sector.
The new rule, issued by the Internal Revenue Service, will affect loans backed by shopping malls, office parks and other commercial properties that have been securitized and sold to investors.
Commercial property owners, who are reeling from plunging property values and a contraction in lending, have had trouble negotiating for extensions or refinancings of such loans that may be coming due in a year or more. Reworking or extending commercial mortgages typically take lengthy negotiations.
Real Estate Mortgage Investment Conduits, or Remics, and so-called grantor trusts, widely used securitization vehicles for commercial mortgages, have been reluctant to rework or extend loans that aren’t in default or at risk of defaulting within six or 12 months for fear of losing their tax-exempt status.
As a result, borrowers aren’t eager to spend money on property upkeep and renovations since they aren’t sure they can hold onto the property when the loan comes due. By the end of 2012, around $153 billion of securitized commercial real-estate loans are coming due, and close to $100 billion of that will face difficulty getting refinanced, according to Deutsche Bank.
“There is today a stalemate caused by tax fears involving borrowers, lenders, servicers and investors” that is holding up “a significant number” of loan modifications and extensions, Jeffrey DeBoer, CEO of the Real Estate Roundtable, which has been pushing for the change.
The new rule would grant leeway to servicers to negotiate with borrowers on performing loans that may not be coming due for some time. The change applies to all loan modifications that were made after Jan. 1, 2008.
Commercial Mortgage Securities Association President Patrick C. Sargent, said the new guidance won’t have a tremendous impact because servicers already have been working with borrowers to extend or modify loans. “Our servicers are considering their situations,” Sargent, whose group represents the servicers, said.
He added that, under the change, servicers would retain ample discretion as to when to modify a loan. Extending a performing loan today that isn’t coming due for another two years just because the borrower is worried frozen credit markets will prevent him from getting an extension is “not compelling,” Sargent added.
Robert Dobilas, president and chief executive of rating agency Realpoint, warned that giving too much flexibility to servicers could cause ratings on the commercial mortgage-backed securities to become more volatile.
“If too much leeway is given to servicers, you may get more people raising their hands to get help,” he said. “Too much flexibility can lead to instability and changes in ratings.”
Concerns are growing that a wave of defaults will hit the commercial real-estate sector, hurting the already fragile economy.
Property values have plunged about 30% to 35% from their peak in 2007, according to DeBoer. Meanwhile, the financial crisis has caused banks and investors to yank back on lending to the sector.
The U.S. commercial real-estate market is roughly $6.7 trillion in size and is underpinned by about $3.5 trillion of debt. Of that debt, about $700 billion are securitized loans.
“A substantial portion of these loans, given what has happened in the macroeconomy and what is happening in the larger credit market, are at risk of default on maturity,” DeBoer argued.
The IRS also on Tuesday finalized a regulation that would expand slightly the types of loan modifications allowed for a Remic to keep its tax status. The agency didn’t extend the new regulation to grantor trusts, as the industry had hoped.
- By Jessica Holzer, Dow Jones Newswires; 202-862-9228; jessica.holzer@dowjones.com
