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‘This Will Be Trouble’: Why Office Landlords Will Soon Face Millions In Added Costs

In recent weeks, it has become increasingly clear that interest rates are going to remain high for longer than most commercial real estate owners initially expected, and they are going to be forced to pay millions in additional expenses as a result.

Not only is there a wave of loans maturing soon that owners will be forced to refinance at much higher rates, but many also face looming expirations on the agreements they reached to hedge against the rising interest rates. These agreements, known as rate swaps and caps, allow borrowers who took out floating-rate loans to keep their interest expenses lower, but they only last for a certain period of time, and for many owners, that time is running out.


These expirations will force borrowers to pay higher rates, in some cases double their previous rate, or enter into new swap contracts that have become much more expensive. With billions of dollars in loans and swap contracts set to expire, these added costs could impact owners across commercial real estate, but experts say they will be especially painful for office landlords who face record-high vacancies and a hostile capital markets landscape.

“We recognize that their rate cap agreements actually have expiration dates prior to their loan's maturity date, which means this will be trouble for the borrower,” Cred iQ CEO Mike Haas told Bisnow. “Once those rate caps expire, they'll have to get a new one, and the cost of those rate caps have gone up exponentially due to the rise in the general interest rate environment.”

Of the 682 floating-rate loans totaling more than $30B that Cred iQ analyzed in March, about 40% of them have interest rate cap agreements that are expected to expire prior to the borrower’s loan maturity date. In the first two quarters of 2024, nearly $10B in rate cap agreements are set to expire.  

The Federal Reserve on Sept. 20 chose to keep the federal funds rate unchanged at a rate of 5.25% to 5.5%, but Chair Jerome Powell indicated the hikes may not be over.

“We're committed to achieving and sustaining a stance of monetary policy that's sufficiently restrictive to bring down inflation,” Powell said at a press conference following the Fed's announcement.

The median projection for where rates will stand at the end of 2024 rose from 4.6% to 5.1% after the September meeting, and the projection for the end of 2025 rose from 3.4% to 3.9%, Seeking Alpha reported. And on Wednesday, Federal Reserve Governor Michelle Bowman said rates “may need to rise further and stay restrictive for some time” to meet the central bank's goals, Bloomberg reported

For borrowers, this could pose a threat as more than $310B in commercial real estate loans are set to mature by the end of 2024, according to Trepp. These loans are entering a completely different borrowing landscape with interest rates sitting at the highest level in years, forcing landlords to take on more costs.

“The cost of interest rate caps are up fairly materially,” said Daniel Ismail, managing director at Green Street. “As interest rates are higher, it becomes costlier to protect against these higher interest rates in terms of buying a swap or a cap.”

New York-based REIT Paramount Group participated in an interest-rate swap for its mortgage at 1301 Sixth Ave. that expired in August, and it has another expiring next year. The company will likely need to pay a higher rate of at least 8%, Crain’s New York reported.

Another office building Paramount owns has a $975M loan set to mature in February, with the rate for a new loan more than double the current rate at 8.5%, according to an Evercore ISI report Crain's cited. The annual interest expense would be raised by $8M, about 10% of the property's cash flow.

A graph from Cred iQ's report showing how many interest rate cap agreements are expiring every quarter.

The Citigroup Center office property in Miami has a $251M loan with an interest rate cap that is is set to expire in July, according to Cred iQ. The cost of the rate cap in March 2022 was $3.2M, but by March 2023 it jumped to $7.6M.

In May, a $310M loan on Blackstone's River North Point property in Chicago went into special servicing ahead of its July maturity, GlobeSt reported. If the loan hadn't gone into special servicing, it would have needed an extension that would have required a new rate cap agreement, according to KBRA

The loan had been in its third extension, but a new agreement would have needed a “meaningful outlay by the borrower,” according to KBRA.

Anthony Paolone, an analyst at JPMorgan Chase who covers REITs, said that most REITs have in-place debt that came from a rate environment completely different from what landlords are experiencing now, and as some look to refinance, they are facing new rates that are more than twice as high. 

“It will be a headwind if this environment persists because if you look at the average coupon rate for fixed-rate debt that REITs have in place now, it’s about 3.8%,” Paolone said.

For office landlords in particular, the higher interest rate environment is just one of many problems that continues to weigh on the sector. Borrowers that have maturing loans and expiring rate cap agreements face a difficult refinancing market.

Paramount Group's 1301 Sixth Ave. property in New York City.

“I think it's extremely substantial, and it's going to impact the probability of a successful refinancing without a significant equity infusion,” Haas said when asked how much this could cost office landlords.

In its second quarter earnings release, Piedmont Office Realty Trust revealed it added $20M in interest expenses after taking on a $400M loan at a 9.25% rate, double what it had paid on its initial loan that was set to mature next year. That contributed to its $2M net loss for the second quarter, and its stock fell more than 7% after the release.

Paolone, who covers Piedmont, said the cost of the refinancing was more than the company had originally estimated.

“The ultimate paper that they issued was more expensive, and we did have to bring our numbers down,” Paolone said. “It reduced earnings estimates.”

During its Q2 earnings call, Boston Properties Executive Vice President Mike LaBelle said the company was watching a $700M unsecured note that is set to expire next year, which he predicted would have almost double the refinancing rate. He warned that the interest rates will “continue to be a headwind as we refinance low-cost expiring debt and anticipated higher rates.”

Green Street's Ismail said that most REITs have about 10% of their debt come due each year, leaving it spaced out enough that the increased costs aren’t as massive of a blow, but they are expected to create stress in the coming quarters. 

“The rising cost of debt has been a key focus for real estate investors for the past 18 months, causing real heartburn given that we’ve seen values decline and interest expenses rise,” Ismail said.