Underwriting in a Down Market
In March 2025, the commercial real estate (CRE) sector is navigating one of its most challenging periods in recent history. With a substantial volume of loans maturing and persistently high interest rates, underwriting in this environment requires a strategic and data-driven approach. The key to success lies in identifying both risks and hidden opportunities.
The Maturity Wall: A Looming Challenge
One of the biggest threats to the market is the "maturity wall." According to the Mortgage Bankers Association (MBA), nearly $957 billion in commercial mortgages are set to mature in 2025, representing about 20% of the total $4.8 trillion outstanding commercial debt. Many of these loans were initially underwritten with the assumption of low interest rates and easy refinancing. However, today’s high-rate environment makes refinancing far more difficult, particularly for asset classes that have struggled post-pandemic, such as office and retail spaces.
A study by CRE Daily highlights that as much as 15% of maturing CRE loans may be too difficult to refinance due to declining property valuations and tightened lending conditions. This presents a risk for lenders but also an opportunity for investors willing to take on distressed assets at a discount.
High Interest Rates: An Ongoing Concern
Unlike past cycles where interest rates fluctuated more dramatically, the Federal Reserve's stance suggests that rates will remain higher for longer. This shift significantly impacts underwriting models, as increased borrowing costs shrink profit margins and reduce the viability of deals. A CAIA report underscores that investors must adapt to this "higher for longer" environment by prioritizing conservative debt structures and incorporating elevated interest rate assumptions into financial models.
Identifying Opportunities in a Down Market
Despite these challenges, a disciplined underwriting approach can uncover valuable opportunities. Below are some of the best strategies to employ:
1. Stress Testing and Scenario Analysis
Stress testing is essential to evaluate how potential interest rate fluctuations, declining property values, and prolonged vacancies could affect an asset.
Stress testing under multiple scenarios is a widely recognized best practice in commercial real estate underwriting. It allows investors to assess resilience and pinpoint properties that can withstand economic shocks, particularly in times of market volatility.
2. Exploring Alternative Financing Solutions
As banks restrict lending, alternative financing options such as private credit, debt funds, and seller financing are becoming more attractive.
Business Insider reports that high-net-worth investors are increasingly turning to private credit as banks pull back, creating a new pool of potential capital for CRE investors.
3. Focusing on Asset Quality and Location
Properties in prime locations with strong tenant demand are more likely to retain value, even in downturns.
Historical data shows that well-located multifamily, industrial, and medical office assets tend to perform better than retail and office properties during economic downturns.
4. Active Portfolio Management
In a volatile market, investors should regularly reassess their holdings, exit underperforming assets, and reallocate capital to sectors demonstrating resilience or growth potential.
Mitigating Risks
To successfully underwrite in a down market, risk management is just as important as identifying opportunities. Key strategies include:
1. Conducting Comprehensive Due Diligence
Analyzing tenant creditworthiness, lease durations, and local market conditions is crucial in preventing unforeseen issues.
A detailed review of T-12 statements and rent rolls can help identify cash flow stability.
2. Maintaining Adequate Liquidity
Ensuring sufficient liquidity can provide a buffer against unforeseen challenges and allow investors to capitalize on distressed opportunities without overleveraging.
Data from the National Association of Real Estate Investment Trusts (NAREIT) suggests that firms with strong liquidity reserves outperform peers during downturns.
3. Implementing Interest Rate Hedging Strategies
Interest rate swaps and caps can protect against rate volatility and preserve cash flows.
CAIA highlights that effective hedging mechanisms have been crucial for institutional investors managing debt exposure.
Leveraging Technology in Underwriting
In this complex environment, technology-driven solutions can significantly improve underwriting efficiency. Platforms like Pro Formance CRE streamline data analysis, enhance scenario analysis, and provide AI-driven insights, helping investors and lenders quickly assess risk and opportunity. By leveraging automation, professionals can make more informed decisions faster, ensuring they remain competitive even in challenging markets.
Conclusion
Underwriting in a down market demands a blend of caution, adaptability, and creativity. By leveraging stress testing, exploring alternative financing, prioritizing asset quality, and maintaining robust risk management strategies, CRE professionals can navigate the challenges of 2025 while positioning themselves for long-term success.
With $957 billion in maturing loans and a complex financing landscape, those who can spot undervalued assets and deploy smart capital allocation will have a competitive edge in the market.
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